Beware the Last Hour of the Trading Day

Life would be calmer if some higher power would herd all the portfolio managers and hedge fund jockeys into a holding tank with no access to computers or trading desks for the final hour of Wall Street action.

Knee-jerk selling blitzes, exacerbated by a herd instinct, mean too many good stock market days go bad -- and bad days worse -- after 3 p.m. Occasional "buying panics" also seem to happen close to the closing bell.

No, it's not rivers of caffeine kicking in. There are technical and behavioral explanations for what occurs:

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Tuesday, January 8, 2008. The market opens higher and is roughly at break-even after lunch. Then AT&T makes an innocuous-sounding comment during an afternoon conference call about a slowdown in a minor part of its business. The Dow Jones industrial average loses 200 points in the final hour and closes down 238.

Thursday, January 10. Stocks open strongly, but the Dow fritters away half of a 200-point gain at the end, although this time there's no clear-cut culprit.

Tuesday, January 15. A bad day from the outset ends up a disastrous one as the Dow surrenders 100 points of a partial recovery in the final minutes of trading. The Nasdaq, down 2.5% on the day, also tanks late in the session.

Thursday, January 17. The market opens terribly, steadies for a few hours, then goes ski jumping after 3 p.m. The Dow loses more than 150 points late in the day and ends down 307. Standard & Poor's 500-stock index and Nasdaq are right alongside.

Wednesday, January 30. The Dow is flat through a suspenseful morning, then soars at 2:15 p.m. when the Federal Reserve cuts interest rates by half a percentage point. An hour later, before anyone has a chance to uncork the champagne, the Dow forfeits the entire gain because of a rumor about more problems at bond-insurance companies.

Tuesday, February 12. Late in the afternoon, the Dow disgorges 150 points from a 200-point gain, then recovers a bit. Nasdaq, however, coughs up all of its gains and then some, ending with a loss after being up 1%. Between 3 p.m. and 3:30 p.m., Nasdaq falls 30 points, or 1.5%.

These aren't the only examples of this annoying pattern. The routine is too frequent to ignore and has become a topic of water-cooler conversation among financial people.

"I've been talking about it here and with some mutual fund managers," says Jim Morgan, chief investment officer of SBLI, a Massachusetts-based life insurance company with $2 billion in assets. He says "some money managers tell me they don't want to have certain positions after a [time] cutoff." They sell stocks in packages before the market closes so they can get their orders filled before they are exposed to losses in after-hours trading.

Jim Jubak, a financial columnist who watches the technical side of stocks and markets, blames the last-hour swoons on automated selling programs and the preservation instinct that consumes the men and women who tee up the sell programs.

Jubak says the market is full of fear and "doesn't trust rallies." Institutional investors with large stock positions wait to see if the Dow or S&P 500 breaks through a "resistance level" in the middle of day before they commit to holding all their shares or possibly buying more. When the index stalls or drops below that threshold, as often happens after a weak retail or jobs report or some important company says something discouraging about earnings, the selling accelerates.

Institutions also want to judge the whole day before they do their mass-trading thing. There's still financial news to digest after midday, although not as much as in the morning, when the government releases its economic figures.

Some quirks may also drive daily trading patterns. Bulls are said to enjoy venturing out for lunch, while bears are too scared to leave their desks, even with BlackBerry devices and Wi-Ri. So they're in position to sell at noon, while their rosier colleagues can then return and see if there's reason to start a post-lunch rally. That, in turn, sets the stage for heartburn.

There's also the fear in a lousy market of getting stuck with dogs after the market closes. (Remember, we're not talking about long-term investors.)

"Nobody wants to hold stuff overnight," Jubak explains, in case the market should open sharply lower in the morning. Because Asian markets are again acting in concert with Wall Street, losses in the Far East feed drops in Europe, which then cycle back to the U.S. This vicious circle will be difficult to break until pessimism is so pervasive that sellers have exhausted themselves and stocks so cheap that buyers can't resist the bargains.

Sadly, you can't do a lot about this. With regular mutual funds, if you enter a sell order while the market is open, you get the closing price, which reflects the final-hour madness.

You can buy and sell exchange-traded funds any time while the market is open. So if you plan to sell an ETF on a down day, push all the buttons by 2:45 p.m. The same is true with individual stocks.

There are exceptions. The most flagrant in 2008 occurred on January 22, when the market did that extreme about-face after the emergency Federal Reserve interest-rate reduction.

Such green-colored turnarounds are rare. Only eight times in the past 20 years has the market been down 3.5% at any point in a day and recovered two-thirds of the losses by the close. The reverse has been true 20 times in the past eight weeks. Or is that just a dream?