What happens in the markets at night?

There are several ways to define volatility. The most common is expressed as the standard deviation, a statistical measure with an intimidating calculation. For the analysis presented here, overnight volatility is defined as the absolute percentage difference between the previous day’s closing price and the opening price. Absolute difference means that the results are expressed as positive numbers, even if the market is down. This reasoning is based on the idea that we want to measure the magnitude of stock market movements, not their direction.

The moving average, also sometimes called the "rolling average," is an average that is constantly recalculated. Each time newer data is added to the calculation, the oldest data is removed. If, for example, we calculate the average of the last five closing prices of a stock on the stock exchange and this calculation is repeated every day, we will effectively be calculating a moving average.

The advantage of using the moving average is that it smooths out short-term bumps and helps keep the overall trend in view. The 200-day moving average (hereinafter 200MA) is one of the most frequently used metrics in the financial industry and that is the one we have used in this analysis.

When the closing price is above its 200-day moving average, the environment is said to be "quiet"; when the closing price is below its 200-day moving average, the environment is considered "turbulent."

It is also relevant here to present some additional information on the research methodology, as well as some historical anecdotes. An analysis was conducted over the past 25 years on the following seven stock markets: Canada, United States, Germany, United Kingdom, Hong Kong, Japan and Australia.

These stock markets account for nearly 80% of global stock market capitalization. The 25-year history includes many complete economic cycles and many different monetary and fiscal policies.

The following table summarizes the number of days that the various markets closed either above or below their 200-day moving average.

Table 1

The notion of a long-term upward trend in stock markets is validated by the fact that the various markets analyzed more often post returns above their 200MA than below.

If the closing prices are below the 200MA, it is generally because the markets are dealing with a truly worrisome situation, which cannot dissipate in a few days. Concerns can arise from a significant deterioration in economic conditions, armed conflicts, trade wars, changes in central bank stance or government regulatory changes, in short, factors likely to impact the profitability of listed companies.

Financial analysts and economists react quickly to new information as it becomes available and portfolio decisions can be implemented quickly. At the same time, computer algorithms are able to analyze information and react by making stock market trades at speeds much faster than humans can. News can come from any time zone: as soon as a stock exchange opens, it quickly adjusts to the new information that was released while it was closed.

The term overnight volatility refers to the rapid and significant adjustment process that occurs in these turbulent environments. Table 2 illustrates this phenomenon well.

In Canada, for example, when the environment is turbulent, it’s normal to see swings of 0.93%, up or down, between the previous day’s closing price and the opening price the next morning. In contrast, when there is nothing particularly worrisome and the markets are trading above their 200MA, the swings are on average 0.54%.

Table 2