Bloomberg Opinion: The Bull Market Caught a Virus

More trading is taking place at the end of the day, including at the closing auction—or the final 4 p.m. trade—which determines end-of-day prices for thousands of stocks.

From the start of this year through Friday, about 23% of trading volume in the 3,000 largest stocks by market value has taken place after 3:30 p.m., according to data from Pragma LLC. That’s compared with about 4% from 12:30 p.m. to 1 p.m.

Closing auctions have grown in volume over the past decade, in part because of the rising popularity of index funds, whose managers passively track indexes like the S&P 500, rather than actively seeking to pick stocks. These types of investments often use closing prices as a benchmark, leading their managers to execute trades at the end of the session.

As index funds have fueled a frenzy of trading at the close, other big investors have shifted much of their trading to the end of the day, taking advantage of the growing presence of big market participants.

Naively you might think that trading would be smooth during the designated half-hour between 3:30 and the close, because it’s when everyone wants to trade and there’s a lot of liquidity; trading during the off hours would be more volatile because there are fewer people to trade with. But in fact:

As investors have fled stocks and rushed into safe-haven assets like government bonds, sudden late-day moves in the stock market have been a staple, creating climactic swoons—and surges—right before the 4 p.m. closing bell.

The Dow has swung an average of about 300 points in the last 30 minutes of trading over the past 10 sessions—including Tuesday’s dramatic rally of roughly 400 points to end the day. That is roughly triple the average swing recorded between 12:30 p.m. and 1 p.m., when activity hovers near its lows of the day, for the same period. …

Patrick Nichols, a partner at trading firm Old Mission Holdings, said he often trades at the end of the session, when exchange-traded funds, pension funds and other investors are also active.

There has been more activity there “than at any other time on planet Earth,” said Mr. Nichols. “Volatility has been exacerbated into the close.”

One model that you could have is that from 9:30 to 3:30, the people who actually move prices in the stock market—giant institutional managers, regular people deciding whether to put money into mutual funds or take it out—are pondering the day’s information, or having meetings or eating lunch or whatever, and then from 3:30 to 4 they are trading based on what they’ve decided. So 3:30 to 4 is the period when the market incorporates information; if the information keeps changing—if the news is wild—then the market will be volatile during those times. The trading from 9:30 to 3:30, meanwhile, is just for practice, high-frequency trading firms trying to bluff each other, that sort of thing. No one has much commitment, so prices don’t move that much. It is obviously not an entirely correct model, but it might capture something.

By the way I’m not committed to a single half-hour session. You could have one in the morning and one in the afternoon. And in fact, these days, people seem to do a lot of their pondering and reacting to news from 4 p.m. through 9:30 a.m. the next day, and then show up at the open ready to move stocks a lot. U.S. stock futures were limit-down overnight for the second time this week; both times, the following morning’s trading session  triggered stock market circuit breakers and led to a 15-minute pause in trading. When times are tough you need two frantic trading sessions to incorporate all the news.

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