Question



Dependent Variable

Should we calculate the (1) equation instead of the (2) equation?

(1) Dependent variable= IF (close_price_today / open_price_tomorrow) >= 1.01 THEN 1 ELSE 0

(2) Dependent variable= IF (close_price_tomorrow / open_price_tomorrow) >= 1.01 THEN 1 ELSE 0


The trader does not want be exposed to bad news after the market closes.

In order to protect themselves from bad exposure when they cannot respond,
wouldn't they rather predict the change in stock price during the time
that they would be exposed without an opportunity to respond?

If they predict a greater than 1% decrease from close today and open tomorrow,
they would try to sell today near closing time and buy at open tomorrow.

Why are we using the (2) equation instead of the (1) equation?





Answers and follow-up questions





Answer or follow-up question 1

Dear student,

You said:

"If they predict a greater than 1% decrease from close today and open tomorrow,
they would try to sell today near closing time and buy at open tomorrow.

Why are we using the (2) equation instead of the (1) equation?"

Answer:

If the bad news comes after closing today and before opening tomorrow,
the trader cannot respond. Yes you can predict if there will be a decrease
from close today to open tomorrow before close, but then you would not
take into account incoming news after trading hours. Therefore traders
do not take any positions over night (sell everything before closing) and
take positions at the beginning of the next day. They make those decision
based on news that is produced over night.

Michel Ballings







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