The Two-Hour-a-Day Trading Plan

The purpose of investing is to make money. But it can be a risky business that comes with both gains and losses. Almost every investor knows that you have to understand how things work if you want to make money. So if you're investing in a stock, you need to come to the table prepared with knowledge about the company, earnings, growth potential, risk factors, and the overall market among other things.

You should also come up with a suitable trading strategy that caters to your needs and investment goals. This article looks at a plan that takes advantage of the surge of activity in the first and last hours of the trading day, commonly referred to as the two-hour-a-day trading plan.

What Is the Two-Hour-a-Day Trading Plan?

If you work a 9 to 5 job and use your evening hours to research stocks and place trade orders for the next day, you (and others like you) are the reason for the first hour of high volume. As soon as the stock market opens, a rush of programmed trades enter the market and are quickly filled.

Along with the trades executed for retail investors, much of the volume comes from mutual funds, hedge funds, and other high-volume traders. Day traders also set their positions for the day during the first hour. All of these factors added together represent a large amount of volume in a short amount of time.

A common rule among day traders is to always end their day without any stock positions, so they must sell their positions at the end of the day. Retail investors who want to avoid day trading rules may purchase stocks at the end of the day, so they are free to sell them the next day if they wish. Some institutions often do not wish to hold large positions over long weekends or holidays when they have no means of liquidating, especially when a big event takes place.

So how can you profit from this phenomenon or at least minimize the chance of a loss? Here are a few ways you can come out on top.

Volume Research

Trading volume is a metric that many traders keep an eye on, so it's important that you understand what it is and how it works.

Volume measures the degree to which an asset is traded during a given period of time. Stock volume tells you how many shares are traded within a specific period. As such, it can provide you with some insight into the mood of the market. For instance, a heavily-traded stock typically indicates a strong market and rising investor interest. And if there's not much volume, there's a very good chance that there's not much interest in the company.

When you research a stock, look at the amount of volatility in the first and last hours of trading. If it tends to be very volatile during those hours, you may be able to buy or sell at a price that is higher or lower than its fundamental value. Set your limit orders unusually high or low to see if you can catch a great bargain in the early minutes of trading.

Use Limit Orders

We mentioned limit orders in the previous section. You can safely trade during the first and last hours of the trading day if you stay disciplined, and the best way to do this is to use limit orders. But what exactly are they?

Limit orders allow you to buy or sell stocks at a certain price or one that's even better. Buy limit orders are only completed at the limit or lower price and the opposite is true for sell limit orders. That is, they are executed at the set limit or higher price.

Still confused? Here's a hypothetical example to show how they work. Let's say you own stock in Company XYZ and don't want to sell them for less than $34.00 per share. You can place a sell order with your broker and set your limit price at $34.00. This way, you're guaranteed to sell your stock at your limit price or better if it gets there. The same strategy can be used when you buy a certain stock.

Trade Today for Tomorrow

Traders who buy and sell a stock on the same day any more than four times in a period of five business days in a margin account (which uses borrowed capital from the broker) are referred to as pattern day traders (PDTs). This is a strategy that is only meant for individuals who are well-versed in trading and the markets. These traders use speculation to make trades within a single day, which allows them to close out all their positions by the end of the day.

In order to trade using the pattern day trader rule, you must be classified as such with your brokerage firm. This means retail investors aren't permitted to use day trading strategies. But there may be instances where you feel you could benefit from multiple trades during the day, so how do you get around this?

Investors can avoid this rule by buying at the end of the day and selling the next day. A trader could hold a stock for less than 24 hours while avoiding day trading rules using this method. Be aware that short-term trading strategies often come with a lot of risks, so it's important to consider careful research and risk management.

Gap Trading

Another way you can take advantage of the two-hour-a-day plan is to employ a gap trading strategy. A gap represents an area of a stock chart when the price takes a sharp move up or down. There is usually very little trading activity—if any at all—that takes place. You can take advantage of and profit from any gaps if you understand them.

Here's an example. Let's say you purchased stock in Company ABC for $30 today and the company announces its quarterly earnings after the market closes. Suppose you feel that the stock will rise to $35 after the announcement, which means when the market opens the next day, the company's stock will begin trading at $35. If you're correct, this creates a $5 gap in the chart, representing a $5 per share profit for you.

The Bottom Line

Whether or not you avoid these hours altogether or aim to confine your trading to these hours largely depends on your risk appetite and experience with the market. Whether you're a new or inexperienced investor, make sure you move carefully during these times. If you don't, you may end up with higher losses at the end of the day.