Why Fading The Opening Gap Is The

Ideal Setup for Me

If you are looking to become a serious trader, there are two
critical questions that you must answer; What is my primary
trade setup? and What is my edge?
When I started out, it seemed like every book, every website, and
every trader touted a different setup each with its own merits!
"ut I knew that I needed a trade that fit me and my trading
personality! #fter lots of searching and introspection I settled on
fading $i!e! trading the opposite direction of% the opening gap in
the indices $e!g! &'( )**, +ow ,*, -asdaq .**, /ussell 0***%!
-ot only do opening gaps occur daily and offer significant profit
opportunity,but they have an inherent directional bias! In fact,
over 1*2 of gaps will retrace from their opening price back to the
prior session closing price that very same day, often in the first
hour of trading!
3urther, the gap fade setup eliminates the stress and frustration
of selecting the right entry and e4it points a challenging
dilemma for many traders and methodologies! In my early days, it
seemed that I often waited too long and missed the entire move,
or worse, entered too early and got stopped out right before it
would reverse and hit my target!
When I was fortunate enough to catch a winning trade, the ne4t
obstacle would often get me5 when to e4it? "eing the competitive
person that I am, I prefer trade setups that have a high winning
percentage! &o, I6d routinely panic at the first sign of a potential
reversal and take profits well ahead of my originally planned
target! 3or visual purposes, it was akin to eating like a mouse $un7
fulfilling% and defecating like an elephant $painful8%! 9he good
news for me was that by focusing on the opening gap, I could
minimi:e e4ecution risks by entering at the open and simply
targeting the gap fill area i!e! the prior day6s closing price!
"ut if I had to pick one single reason the opening gap fade setup
is perfect for me, it is this5 I can trade it with the same advantage
of a professional card counter in ;as <egas5 a mathematical edge!
9ime and time again in my early days of trading, I found myself
cherry7picking setups and invariably selecting most of the losers
and missing many of the easy winners! It was an endlessly
frustrating e4perience to put it mildly, and I knew the problem
was that I did not have any data that I trusted supporting my
setups! =owever, by focusing on fading the gap, I was able to
back7test and calculate historical probabilities for my trades, 3or
my trading style, developing a mathematical edge was critical to
my success in sticking with a setup!
>y first research breakthrough was in recogni:ing that gap
selection was the door to making profits and the key to that
door was to focus on the location of the opening price! ?sing the
prior day6s direction $up or down% and the open, high, low, and
closing prices, I created ten :ones and each provides
tremendous insight into the probability of a gap filling or
not! <iew my @ap Aone >ap! >y selection strategy has evolved
over the years to include market conditions, patterns and
seasonality, but :ones remain the foundation of my gap fade
selection criteria!
&o why do :ones work? If you think about it, they inherently
incorporate 5
B proven support and resistance levels
B short term trend
B gap si:e
B trader psychology
9ogether these four elements combine to create a wide range of
gap fade scenarios that vary from high probability to high risk!
&ince opening gaps in general have a strong tendency to trade
back to the prior day6s closing price, the name of the game is not
trying to catch all of the winners but rather to avoid most of the
losers, and that is what :ones do very well!
<iew the historical probabilities of a wining gap fade $i!e! gap fill
or finished the day profitably% for each :one in the &'( )** since
.CCD! -ote5 these probabilities are for the &'( )** e7mini
futures, but the &(E e4change traded fund shows similar results,
in fact all of the ?& indices show comparable historical
probabilities!
&o why do you think gaps in the ?7; :one $bottom right of the
@ap Aone >ap% show such a low historical win rate $)F2%? I
believe it6s because gaps opening in this :one are catching traders
positioned to the long side off guard, triggering many sell stops in
the process! (lus, such an obvious reversal from the prior day
surely attracts new short sellers who want to Gump on board the
beginning of a new potential trend! I6ve nicknamed this :one the
";?+ :one for obvious reasons, plus it6s easy to remember5
"elow the ;ow of an ?p +ay! If you do nothing else but avoid
fading these gaps, youHll be a better gap trader in the long run!
Whether you trade the opening gap as a setup or Gust want to
improve the timing of your swing trade entries and e4its, you will
do a better Gob, if you pay attention to the :one ne4t time! Idea5
try tracking the opening location of your favorite trading
instrument and itHs frequency of gap fill! 9he results may surprise
you and may help you filter your other trades too! #nd if you are
looking for a new setup with a well7defined edge, check out the
opening gaps in the indices!
@ood trading and good gapping8
&cott #ndrews
>asterthe@ap!com
(!&! I post free daily gap wrap videos in the 3ree Info &ection of
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