Market Fades the Gap for the 100th Time
Not to be cynical, but I’m beginning to be able to fade the gaps each morning in my sleep. If I dream about a gap, it fills. This most basic and simple strategy is paying out more than any complex strategy right now.
It happened again today, almost with a yawn:
Feel free to search the blog for more examples, and a detailed explanation on how I trade the strategy, but the basics are always the same:
If there is an overnight gap in the US Indexes, as evidenced through their Exchange Traded Funds (ETFS), then the first play is to establish a trade that would close the gap (buy gaps down and short gaps up):
Dow Jones: DIA
NASDAQ: QQQQ
S&P 500: SPY
I usually give 5 to 10 minutes for the market to shake out with volatility and then enter a position and, depending on the size of the gap, I will make a decision based on the stop.
If the gap is greater than 100 Dow points ($1.00 on the DIA ETF) then I will be tighter with my stop, but with anything else, I will place my stop ½ the distance of the gap.
For example, if a DIA gap is $0.50 (50 Dow Points) then I’m likely to place a stop $0.25 away from my entry and play for a 1:2 risk to reward trade. I’ll often move the stop up to the intraday low if it develops, or I will be stopped out. I may re-enter depending on subsequent action.
Today’s action was a classic fade, though it was greater than 100 Dow points ($1.00 on the DIA).
Nevertheless, the market filled the gap with amazing wonder, as has become the case more times than not (giving you a statistical edge for trading).
There’s no way to know how long this pay-out cycle will last, but until it stops, or for some reason (everyone catches on) the edge is degraded, I will trade gap fades very aggressively, as those trades are making me the most money with my intraday trading than any other complex strategy I use at the moment.
I hope the gap fades are good to you too!
(Note, some people like to see an index gap and then try to trade a more volatile security to play for more dollars in their gap fades, especially with stocks that are part of the index that is showing a gap, and has shown to follow the index price action closely. This way they get more ‘bang’ (or money) for their gap-fill trade)
How many days in January opened with a gap? What was the success rate with the gap fade?
I enjoy your blog and although I don’t trade short term gaps I like to stick to the simple stuff that works and milk it for all its worth as well so glad to see this is working out for you. Best Regards, Dave
Corey —
Found your blog because of these gap fade articles. So far I’m really enjoying your analysis and I’m learning a lot. Keep up the good work.
Do you trade DIA exclusively on these trades? If SPY, QQQQ, and DIA all gap, which one(s) will you trade?
Also happy to see more info today about how you set your stops. I tried a gap fade with QQQQs today, but overmanaged it; I scratched after I saw shooting stars print in the 2nd and 3rd bars/5′ charts. (And on cue, the market took off as soon as I bailed. I hate it when that happens.) It ended up retesting the low before bouncing, similar to your 1′ chart of DIA posted a few days ago. (Which I also read today, too late to help me on this mornings trade. D’oh!). Do you trail your stop after moving it up to the intraday low, or is that one move all you make?
Corey,
Thanks for your series of posts on gap fades. Interesting!
If DOW gaps more than 100 points, how do you usually set your stop?
From your gap fade experience, is there anything one should look out for to stack the probability higher that the gap will indeed fade? Such looking at volume or anything other technical indicators?
CT,
I have compiled the quick stats you requested on the most recent front page post.
Thank you for the question and the inspiration.
Thanks Dave!
Wolverine,
I am most comfortable with the Dow Jones Index, and I’ve watched it ever since I was a very young boy, so I understand the numbers and the 30 stocks that make it than the other indexes. I now exclusively trade the DIA and the Dow-Mini futures contract when it comes to US Indexes. If I’m more confident with the ETF/market gap, I’ll play out my bias with the Dow Mini for added leverage.
I usually wait to see a couple of clues if the gap will fade and if it’s already heading up, I join and place my stop beyond the intraday low so as to manage risk. If somehow I miss the gap, or am ‘freaked out’ by it and it’s already filled halfway, or to such a point where my stop would leave me with a 1 to 1 risk to reward (or worse), then I pass on the trade and try not to berate myself.
I try not to advocate (teach) a hard stop rule, because I separate over conservative and overly aggressive traders based on personality. I tend to be over-conservative and that’s my fault I deal with. What I do with my trading, I might not recommend for everyone because others should take more risk (larger stop) than I do.
But still, it comes down to the profit target and expected profit. Try to go for at a minimum of a 2 to 1 reward to risk.
Yes, a couple of days ago, I was victim to this and was sweating it out and ready to kill my trade but forbade myself (I’d done that way too many times) and decided not to micromanage, and when I was about to kill the trade… it rallied and achieved its objective. You never know what’s going to happen in the market and each day seems unique!
Thanks
Jordan,
No problem! I don’t know if I’m becoming an expert on this, or if the market is just being overly generous!
Just like I said to Wolverine, the cut-and-dried answer is to tie it to the target. Maybe with a larger gap, try for a 3 to 1 reward risk (such that if I play for $1.00, then I’ll give up $0.33 of a stop away from entry). I generally don’t let it get that far, because I’m far more likely to kill a trade than try to give it the benefit of the doubt, but that’s not the right thing to do, so I try not to teach what I do. It’s kind of that “do as I say, not as I do” notion where you really need to give the trade breathing room.
But I know that – with the exception of this market – a Dow gap greater than 100 points has lower odds of filling than one of less than 100. For that reason alone, I may use a tighter stop of 20 cents or so beyond the intraday high/low (which is generally too tight).
Oh gosh, you know I’ve tried almost everything but I’ve found the simplest things work the best. I brought that up briefly in my most recent front-page post, but I’ve found that trying to tweak the basic strategy degrades it for me. You really need to enter quickly and play for the target, and IF you are stopped out convincingly, it often pays to flip the position and play for a larger target IN the direction of the gap (because gaps are impulse moves). That’s really what I do.
I do not recommend using stochastics, RSI, CCI, MACD (not even the 3/10 setting that I love so much), ROC, moving averages. None of that matters. All that matters is yesterday’s close and whether or not current price is moving towards or away from that zone. That sets your target and that’s all you need.
You could look at the size of the current 15-minute bar in relation to the previous 7 or more 15-minute bars, or perhaps do the same with 30-minute bars if the gap hasn’t yet filled, and perhaps compare volume. The TICK, TRIN, and Breadth can serve as confirmation, but honestly every time I’ve seen a gap, I’ve seen immense disparities in Breadth that close when the gap is faded. I keep up the TICK, TRIN, and Breadth on all intraday charts but I’ve been relying on them less now than I used to in the past.
I don’t do much back-testing either anymore and so I need to do so. Still, I reference that the simple strategies work best, and trying to tweak them may degrade them.
I’m open to any suggestions from anyone!