Exchange-reported information about market imbalances offers opportunistic traders a rare glimpse of where a stock’s share price could be headed in the opening and closing minutes of the trading day. Here’s an overview about what you need to know about market imbalances, how you can trade this important information, and the risks involved in market imbalance trading.
Market imbalance, also called order imbalance, occurs when there is an excess number of buy or sell orders for a given stock at a particular time. These types of imbalances are often responsible for the extreme moves in share price following a particularly good or bad news headline. Typically, these market imbalances work themselves out relatively quickly. As the imbalance pushes a stock’s share price higher or lower, more traders on the other side of the trade step in to take advantage of the move and eliminate the imbalance naturally.
News-related imbalances can be somewhat unpredictable, but certain traders take advantage of the imbalances in the market that naturally tend to occur at the beginning and the end of every trading day.
In the last hour of trading and in the two minutes prior to the market open every day, exchanges publish information on imbalances for individual stocks through their data feeds. Information about one particular type of order called a market-on-close order can be particularly useful to market imbalance traders. Market-on-close orders are orders to buy or sell shares at the last market price of the day at or just after the closing bell. By rule, these orders must be placed at least 15 minutes prior to the closing bell at 4 p.m. ET.
Traders watching the imbalance feed at 3:45 p.m. can look for large end-of-day imbalances in particular stocks. If a stock has a large buy imbalance, the stock’s share price may rise in the last 15 minutes of trading as traders recognize the bullish market-on-close imbalance. In addition, sellers may see a large buy imbalance as an opportunity to set limit sell orders slightly above the current market price headed into the close, in hopes that they can pick up a few extra cents from all the market-on-close orders.
As with many trading strategies, the idea of trading market imbalances is a lot simpler in principle than it is in execution. High-frequency trading algorithms can sometimes manipulate closing imbalances in the last few minutes of a market session, issuing large orders that can eliminate or even flip a stock’s imbalance in milliseconds.
In addition, the more traders that are watching for these imbalances, the more efficient the market is in quickly eliminating the imbalances along with any potential trading opportunity.
Finally, these end-of-day market imbalances are typically only large enough to produce very small moves in share price, meaning traders need to place large orders or have high leverage to make meaningful profits by trading these swings. It’s particularly difficult to profit on the small swings when trading commissions are involved as well.
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