Using Gap Zones to Create a Profitable Strategy for the Opening Gap Scott Andrews.
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Transcript of Using Gap Zones to Create a Profitable Strategy for the Opening Gap Scott Andrews.
Using Gap Zones to Create a Profitable Strategy
for the Opening Gap
Scott Andrews
Disclaimer This material is intended for educational purposes only and is believed to be accurate, but its accuracy is not guaranteed. Trading and investing has
large potential rewards and large potential risks. You must be aware of, and fully understand, these risks and be willing to accept them in order to
invest in equity, futures, options, currencies and other financial markets. Do not trade with money that you cannot afford to lose. This material is neither
a solicitation nor an offer to buy or sell equities, futures, options, or currencies. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed. The past performance of any trading system or methodology is not necessarily
indicative of future results. Use this information at your own risk!
Copyright NoticeAll materials contained in this presentation are protected by United States
copyright law and may not be reproduced, distributed, transmitted displayed, published or broadcast without the prior written consent of
Master The Gap, Inc.
Overview
• The Basics, Promise & Dilemma• Solution: Gap Zones• The Math• Two Weeks in the Life of a
“Gapper”• Summary • Q & A
Definitions
• Gap – difference between the prior day close and next day’s opening price (regular session / pit hours).
• Fade – to trade in the opposite direction of the gap.• Gap Fill – when price retraces from the opening back to the prior
day’s close.• Win Rate – percent of gaps that, if faded at the open, filled the gap
or could have been exited at the end of the day for a profit.• Profit Factor – the ratio: (profits from winners) / (losses from losers)
measures the historical profitability of a given setup. This is more important than “win rate.”
• “Gapper” - a unique individual that has evolved beyond his/her trading peers by recognizing the superior return on time, effort and capital of the "gap fade." This elite trader can be recognized by his/her enviable lifestyle & finances.
Why I Love Gaps1. Gaps have an inherent bias and edge (>70% win rate).
2. They occur frequently (three to four tradable gaps per week in the S&P).
3. It's an easy trade to learn and play.
4. I can prepare in about 15 minutes before open.
5. I can trade them without charts and from anywhere.
6. Getting filled with minimal slippage is not an issue.
7. The entry and target are pre-defined so I don't have to manage the trade.
8. My risks are limited and controlled - no overnight risk.
9. They work in bull and bear markets equally well – no need to predict the market’s next move.
10. They occur in most asset classes and can be traded using stock, options, and futures
contracts.
11. I can grow my account significantly with this single, simple setup & one market.
12. Understanding the bias of the market before and after the gap fills, provides a trading edge for
the rest of the day while also helping optimize my entries on swing and position trades.
The Promise of Gap FadingYear Number of Gaps Win %
2008* 79* 72.2%
2007 225 64.9%
2006 200 72.5%
2005 196 71.4%
2004 213 72.3%
2003 211 75.4%
2002 229 73.4%
2001 208 74.0%
2000 223 73.5%
1999 236 75.9%
1998 226 73.0%
Total: 2,246 72.4%* January 1 - April 30, 2008
“Win %” is based upon hypothetically fading opening gaps > 1 point in the E-Mini S&P 500 futures, 1998-2007, using no stop, targeting prior close, exiting end of day if gap did not fill. This not a recommended strategy.
The ParadoxYear Profit Factor 2008* 1.24
2007 0.71
2006 1.01
2005 1.05
2004 1.11
2003 1.30
2002 1.14
2001 1.16
2000 0.94
1999 1.14
1998 1.06
Average: 1.08 (yawn)• January 1 - April 30, 2008
Profit factor = total profits of winners / total losses from losers
Though an extremely high win rate, the profits from the winners barely exceed the losses from the losers.
Though an extremely high win rate, the profits from the winners barely exceed the losses from the losers.
The DilemmaStop As % of
Gap Size% Win Average
Win/Loss RatioProfit Factor
25% 21.4 3.49 0.95
50% 36.0 1.80 1.01
75% 47.0 1.18 1.05
100% 53.7 0.91 1.06
125% 59.0 0.73 1.05
150% 61.8 0.64 1.04
175% 64.7 0.57 1.05
200% 66.1 0.53 1.03
Note: 1998 – 2007, E-Mini S&P 500 futures.
Using small stops does not improve profitability due to the reduction in win rate.
Using small stops does not improve profitability due to the reduction in win rate.
The key to making money fading opening gaps is…
SELECTION
Filter by “Size of Gap”?
Fading 1- 3 point gaps at the open, using a 6 point stop: – 78.0 % filled or finished profitable (687/881)– Profit factor: 1.17
Fading gaps > 10 pts at the open, using a 6 point stop: – 37.5% filled or finished the day profitable (91/243) – Profit factor = 1.17
Note: based on E-mini S&P 500 futures, 1998 - 2007
Gap size is not correlated with profitability. Gap size is not correlated with profitability.
A Solution…
“Gap Zones”
Definition: location of the gap
relative to the prior day’s key
price levels: Open, High, Low
and Close.
High
Close
Open
Low
“Location, location, location”… applies to gaps too! “Location, location, location”… applies to gaps too!
Why Gap Zones Work
They inherently incorporate:
• Support and resistance• Short term trend• Gap size• Trader psychology
High
Close
Open
Low
Gap Zone AreasPrior Day Potential Next Day Gap Areas
Above the high
Below the high & above the open or close
Between the open and close
Below the open or close& above the low
Below the low
Gap Fade Win %
All gaps > 1 point = 72.4 %
“Win %” is based upon hypothetically fading opening gaps > 1 point in the E-Mini S&P 500 futures, 1998-2007, using no stop, targeting prior close, exiting end of day if gap did not fill. This not a recommended strategy.
Gap Fade Win % By ZonePrior Day Historical Win Rate
69%
76%
75%
76%
63%
“Win %” is based upon hypothetically fading opening gaps > 1 point in the E-Mini S&P 500 futures, 1998-2007, using no stop, targeting prior close, exiting end of day if gap did not fill. This not a recommended strategy.
Direction of Prior Day Should Be Considered Too
Open
Close
Close
Open
Prior day “direction” incorporates the short term trend.Prior day “direction” incorporates the short term trend.
The Math…
Gap Fade Win % By Gap ZoneWin % Prior Day
59%
66%
75%
78%
65%
“Win %” is based upon hypothetically fading opening gaps > 1 point in the E-Mini S&P 500 futures, 1998-2007, using no stop, targeting prior close, exiting end of day if gap did not fill. This not a recommended strategy.
Prior Day Win %
71%
82%
75%
72%
54%
Let’s Compare Similar Gaps in Four of the Zones…
Zone BZone A
Zone C Zone D
Test Scenarios
• 3-7 point gaps• Four zones: 2 long & 2 short strategies• Test 3 targets: exit end of day, gap fill, & 3 points beyond• Test “no stop” & 6 point stop• Compare win rate • Compare profit factor (pf)
Scenario #1: No target, no stop, exit EOD
A
C D
B
Baseline: 48% win rate, 1.0 pf (all zones)Baseline: 48% win rate, 1.0 pf (all zones)
48% win.73 pf
53% win1.27 pf
42% win.51 pf
52% win.98 pf
Best “fade” candidate
Best “go with” candidate
Scenario #2: Target gap fill, no stop
A
C D
B
Baseline: 71% win rate, 1.05 pf (all zones)Baseline: 71% win rate, 1.05 pf (all zones)
65% win.87 pf
76% win1.11 pf
68% win.84 pf
55% win.75 pf
Historicallyprofitable even withno stop
Scenario #3: Target gap fill, 6 pt stop
A
C D
B
Baseline: 61% win rate, 1.14 pf (all zones)Baseline: 61% win rate, 1.14 pf (all zones)
59% win1.22 pf
68% win1.33 pf
55% win.85 pf
48%.85 pf
Using a stop made this a viable fade candidate
Getting very interesting…
Scenario #4: Target 3 pts past gap fill, 6 pt stop
A
C D
B
Baseline: 48% win rate, 1.09 pf (all zones)Baseline: 48% win rate, 1.09 pf (all zones)
49% win1.15 pf
58% win1.52 pf
36%.67 pf
41%.71 pf
Now we’retalking!
YUCKYUCK
BLUD!(below low of up day)
What Is Obvious? Scenario #1No target, no
stop, exit EOD
Scenario #2Target gap fill, no stop
Scenario #3Target gap
fill, 6 pt stop
Scenario #4Target 3 pts beyond gap fill, 6 pt stop
All Zones 48% win1.0 pf
71%1.05 pf
61%1.14 pf
48%1.09 pf
Zone A 48% win.73 pf
65%.87 pf
59%1.22 pf
49%1.15 pf
Zone B 53% win1.27 pf
76%1.11 pf
68%1.33 pf
58%1.52 pf
Zone C 42% win.51 pf
68% .84 pf
55%.85 pf
36%.67 pf
Zone D 52% win.98 pf
55%.75 pf
48%.85 pf
41%.71 pf
Most zones have a bias to fill, but some do not.Most zones have a bias to fill, but some do not.
Scenario #1No target, no
stop, exit EOD
Scenario #2Target gap fill, no stop
Scenario #3Target gap
fill, 6 pt stop
Scenario #4Target 3 pts beyond gap fill, 6 pt stop
All Zones 48% win1.0 pf
71%1.05 pf
61%1.14 pf
48%1.09 pf
Zone A 48% win.73 pf
65%.87 pf
59%1.22 pf
49%1.15 pf
Zone B 53% win1.27 pf
76%1.11 pf
68%1.33 pf
58%1.52 pf
Zone C 42% win.51 pf
68% .84 pf
55%.85 pf
36%.67 pf
Zone D 52% win.98 pf
55%.75 pf
48%.85 pf
41%.71 pf“BLUD” zone: Below Low of Up Day
Tip: Don’t Fade da’ BLUDs!
Two weeks in the life of a “gapper”…
How I Trade Gaps• Direction: mostly "fades" – though I do have a couple "go with" signals
• Pre-market Filters: primarily on where the gap opens (i.e. gap zone)
• Gap Size: totally dependent upon the zone
• Decision Time: based upon where prices are trading at 9:25 am ET
• Position Size: one contract for every $10,000 of equity
• Risk Management: if I’ve identified one or more risk factors, then I reduce my position size
• Stops: based upon points or a percentage of the gap amount, optimized by zone. I use a time-stop for some zones
• Targets: before, at gap fill, or beyond gap fill, depending upon the zone
• Entry Technique: at open (9:30 ET) using a market OCO (“One Cancels Other”) bracket order
• Exit Technique: at my target or stop, or end of day if neither hit. I never hold overnight. I manage some positions intraday.
Monday, April 7, 2008
Gap: up 9.5 pts
Zone: below high & above open of prior “down” day
Action: half size short at open
Result: -6 pts ($300) per contract
Time in trade: 3 hr, 25 min
Tuesday, April 8, 2008
Gap: down 7.25 pts
Zone: below low of prior “down” day
Action: no trade
Result: missed a winner
Wednesday, April 9, 2008
Gap: down 2.25 pts Zone: below close &
above open of prior “up” day
Action: short half size (“go with” trade) at open
Result: +3 pts ($150) per contract; scaled out +2.25, +3, +5
Time in trade: 28 min
Thursday, April 10, 2008
Gap: down 3.5 pts
Zone: below close & above low of prior “down” day
Action: long at open
Result: +6.45 pts ($322) per contract, scaled out: +6 and +8.25 pts
Time in trade: 1 hr, 46 min
Friday, April 11, 2008
Gap: down 16 pts
Zone: “BLUD” - below low of prior “up” day
Action: no trade
Result: good call
Monday, April 14, 2008
Gap: down 1.75 ptsZone: below close of
prior “down” dayAction: half size long
at openResult: closed at end
of day for -2 pts ($100) per contract
Tuesday, April 15, 2008
Gap: up 7 pointsZone: above high of prior
“down” dayAction: short at openResult: +4.3 pts ($215)
per contract; scaled out +4, +6, and +5 pts
Time in trade: 1 hr, 29 min
Wednesday, April 16, 2008
Gap: up 11.25 pts
Zone: above high of prior “down” day
Action: half size short at open
Result: stopped for a full loss (-6 pts) ($300) per contract
Time in trade: 1hr, 25 min
Thursday, April 17, 2008
Gap: down 8.75 ptsZone: below close, above
open of prior “up” dayAction: half size,
discretionary (no signal) long at open
Result: +5.33 pts (+$266.5) per contract (scaled out: +6, +3, and +8)
Time in trade: 6 hr, 6 min.
Friday, April 18, 2008
Gap: up 19.75 pts
Zone: above high of prior “up” day
Action: no trade
Result: good call
Summary
• The “gap fade” is a simple trade & a great
foundation for a trading plan
• Know the zone!
• It pays to be picky
• Don’t leave money on the table - know which
ones to close before or beyond gap fill