Morning gap trading strategies
Are you having trouble with these annoying morning gaps? You are not alone. Many traders spend hours working on new rigs only to watch them turn to smoke in the morning. Still, there is no need to cross out all of your hard work. You can do a quick analysis, adjust your trading strategy, and enter good positions a little later after the crowd jumps into the gap.
Many traders still place market orders before the open and leave. Unfortunately, this is not the best solution. Take a few extra minutes to schedule your gap entry and you’ll get much better prices. This is not only true for day traders, although it will benefit anyone who plays the day markets. This is more suitable for swing traders looking to improve their market entry and get positions where they can maximize their profits. Below are some strategies you can use to do this.
Stay on the sidelines during the open and use the three bar swing to find the best gap entry. This is a robust reversal or expanding move on a five minute chart that occurs on the 11th or12th minute at the start of a new trading day. This phenomenon in the stock market remains from the old 15 minute delays in quotations. In years past, this time before retail investors could access stock prices warranted a few extra pennies for market insiders. Since retail players were the last in line, real market forces could then consume their orders and cause a reversal or breakout. Although almost all markets are now accessed in real time, this three-bar wobble is often still quite relevant.
Let the market form the first three five-minute bars and then use the high and low of the range of these three bars as resistance and support levels. A buy signal occurs when the price exceeds the high of the three-bar range after an upward gap. A sell signal occurs when price breaks the low of a three-bar range after a downward gap. This is a fairly simple technique that works well in many cases. If you use this technique, though, take a few guidelines to avoid quick reversals and other market pitfalls. The most common is the first swing, which lasts longer than three bars. If the obvious range is four, five, or even six bars, use them to identify support and resistance levels. Also consider the higher noise level in the 5 minute graphs. Breakouts that only extend by one or two ticks can easily reverse and lead you to sudden losses. Therefore, leave this bait to others while you can find pullbacks and narrow range bars to trade.
The location of the gap is more important than the gap itself. Is the opening bar pushing the price towards long-term support or resistance? A strong gap can take a market instrument through several resistance levels and firmly anchor it at the top of new support. Or it can push the price directly onto an insurmountable barrier, where the price moves further along the path with least resistance.
Three-bar range support and resistance is often needed to complete testing of patterns before they move to higher or lower targets. This comes in the form of a small cup and handle, or a reverse cup and handle. Quite simply, price reverses the first time it tries to break through an old high or low, but succeeds on the next attempt.
Price gaps also form other levels of activity. The most obvious is the support line with an upward gap (or a resistance line with a downward gap). We will call these the “breakout” lines. A breakout violation can cause price acceleration towards the gap filling line. This market mechanic makes sense: everyone who enters a position in the direction of the gap loses money as soon as price moves past the breakout line.
The gap filling line marks support with an upward gap and resistance with a downward gap. In other words, the odds are reversed when the price hits this line. Paradoxically, this is not the best place to enter new positions when trading swing. The retracement line will keep the price from returning to a three-bar range. In fact, price bounces like a tennis ball from the fill line to the breakout line and back to the fill line, giving a powerful trading signal in the opposite direction. This predicts gap failure and significant reversal.
The flip side of this reversal is the failed attempt signal. In other words, the price breaks the resistance on the breakout line and retests the high of the gap up (or the low of the gap down). The ability of prices to retest these levels gives a strong signal to take positions in the direction of the gap.