HowITradeGaps-030213

How I Use Historical Probabilities to Trade the Opening Gap

Scott Andrews

Copyright 2013, MasterTheGap.com

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!!


Agenda Ø  The Basics Ø  How I Trade Gaps Ø  Selection Criteria Ø  Execution Ø  How To Get More Free Research


Gap Basics


What Does a Gap Look Like?

GAP


Example of Gap: Daily Chart

Close

$48.38 •  Next day gaps down •  Opens at $47.61 •  Fills the gap precisely


Example of Gap: 5 Min Chart

Next day opening price (9:30 am ET)

Price retraces & fills gap

Prior day closing price (4:00 pm ET)


The Easiest Trade of The Day 1. 

Gaps have an inherent bias and edge (70% win rate).

2. 

Can prepare in minutes before open.

3. 

Can trade them without charts from anywhere.

4. 

Minimal slippage due to opening volume.

5. 

“Fire & forget” – place order and walk away.

6. 

Entry & target are pre-defined, no need to manage

7. 

Risks are limited and controlled - no overnight risk.

8. 

They work in bull and bear markets equally well – no need to predict the market’s next move. Copyright 2013, MasterTheGap.com

Definitions u 

u 

Fade:

to trade in the opposite direction of the gap

Gap Fill: when price retraces from the open to the prior day's close (4:15 pm ET) Win %:

percent of opening gaps that, if faded at the open, fill the gap or end the day profitable

Profit Factor:

ratio =

u 

ES:

E-mini S&P futures

u 

ATR:

Average True Range (the average range of each session, inclusive of opening gaps)

u 

u 

gross profits from winning trades gross losses from losing trades


The Promise of Gap Fading Year

Number of Gaps

Win %*

2012

227

69%

2011

243

67%

2010

228

71%

2009

236

69%

2008

235

68%

2007

223

64%

2006

203

73%

2005

194

72%

2004

205

71%

2003

204

76%

2002

228

74%

Total:

2,426

70.4%

*Win %” is based upon hypothetically fading opening gaps > 1 point in the E-Mini S&P 500 futures, 2002-2012, targeting prior close, exiting end of day if gap did not fill. This not a recommended strategy.

* January 1 - April 30, 2008


The Paradox Year

Profit Factor*

2012

1.10

2011

1.01

2010

1.20

2009

1.21

2008

0.88

2007

0.72

2006

1.04

2005

1.13

2004

1.17

2003

1.38

2002

1.21

Average: •  January

1.10 (yawn)

*Based upon hypothetically fading opening gaps > 1 point in the E-Mini S&P 500 futures, 2002-2012, prior2008 close, exiting end of day if gap did not fill. This not a recommended strategy. 1 targeting - April 30,

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. Copyright 2013, MasterTheGap.com

Using Stops Does NOT Improve Profitability Stop As % of Gap Size

% Win

Average Win/Loss Ratio

Profit Factor

25%

20%

4.1

1.04

50%

35%

2.0

1.07

75%

45%

1.3

1.03

100%

51%

1.0

1.05

125%

57%

.80

1.05

150%

60%

.70

1.05

175%

62%

.65

1.05

200%

64%

.60

1.05

*Based upon hypothetically fading opening gaps > 1 point in the E-Mini S&P 500 futures, 2002-2012, targeting prior close using a stop = % of gap size. This not a recommended strategy.

Note: 1998 – 2007, E-Mini S&P 500 futures.

Regardless of stop size, fading all gaps remains a breakeven strategy. Copyright 2013, MasterTheGap.com

The Key to Profitability:

SELECTION


How I Trade Gaps


Select Trades Like John Venn

Trade only when the majority of historical criteria are supportive Copyright 2012, Master The Gap, Inc. Copyright 2013, MasterTheGap.com

How I Select Gaps to Fade Pattern Market Condition

$

Seasonality

Zone I analyze each gap based on it’s opening zone and how it has performed historically under similar scenarios Copyright 2013, MasterTheGap.com

“Gap Zones”

High Close

Definition: location of the gap relative to the prior day’s key price levels: Open, High, Low and Close. Open Low “Location, location, location”… applies to gaps too! Copyright 2013, MasterTheGap.com

Why Gap Zones Work High They inherently incorporate: •  •  •  • 

Support and resistance Short term trend Gap size Trader psychology

Close

Open Low


Direction of Prior Day Should Be Considered Too Open

Close

Close

Open

Prior day “direction” incorporates the short term trend. Copyright 2013, MasterTheGap.com

Gap Fade Win % By Gap Zone Win %

Prior Day

Prior Day

Win %

55%

65%

62%

84%

73%

75%

81%

70%

66%

53%

“Win %” is based upon hypothetically fading ~2,500 opening gaps > 1 point in the E-Mini S&P 500 futures, 2002-2012, targeting prior close, exiting end of day if gap did not fill. This not a recommended strategy. Copyright 2013, MasterTheGap.com

Tip: Avoid Gaps That Open Below the Low of an Up Day Prior Day

AVOID! BLUD Gaps! Copyright 2013, MasterTheGap.com

Entry Timing


Why I Enter At The Open Ø 

Simplifies execution

Ø 

Minimizes emotion

Ø 

Takes advantage of “rookie” psychology (i.e. those chasing the market)

Ø 

Easier to back-test

Ø 

Focuses the effort on the system (not me)

Ø 

Catches all of the winners... Copyright 2013, MasterTheGap.com

Stop Placement


The Stop Dilemma Stop As % of Gap Size

% Win

Average Win/Loss Ratio

Profit Factor

25%

20%

4.1

1.04

50%

35%

2.0

1.07

75%

45%

1.3

1.03

100%

51%

1.0

1.05

125%

57%

.80

1.05

150%

60%

.70

1.05

175%

62%

.65

1.05

200%

64%

.60

1.05

*Based upon hypothetically fading opening gaps > 1 point in the E-Mini S&P 500 futures, 2002-2012, targeting prior close using a stop = % of gap size. This not a recommended strategy.

Using small stops does not improve profitability due to the reduction in win rate. Copyright 2013, MasterTheGap.com

Stops •  25% – 40% of a five day ATR (avg. true range) works well for most market / equities depending upon the volatility of the security •  50 – 80 cents in the SPY or 5 – 8 points in the E-mini S&P 500 has worked well historically •  If I increase stop size to accommodate volatility, then I always reduce position size to ensure my max loss per trade is not exceeded •  I never hold losing trades overnight

Stop size is more of a personal preference than profitability determinant Copyright 2013, MasterTheGap.com

Results of My Called* Gap Trades: 2011-2012 •  •  •  • 

113 wins 56 losses, 3 scratch ~ 67% win rate ~ 1.28 profit factor (ratio of profits to losses from all trades)

* Each was posted at “Today’s Gap Plays” page on the website for members prior to the opening bell and prior to my entry.

Individual results vary. There is no guarantee that I or my methodology will enjoy similar success in the future. Copyright 2013, MasterTheGap.com

Summary •  Historical probabilities level the playing field between the “Pros” and the “Joes” •  Gap selection is THE key •  Know the zone! •  Entering at the open has many benefits •  Use a stop size that fits you & your desired win rate Thank You Copyright 2013, MasterTheGap.com

Go to:

www.masterthegap.com/tradingpub … for a copy of the slides and a BONUS video:

“8 Gap Facts Every Trader Needs to Know”


If you would like to learn more about: Gap Trading using Historical Probabilities… Join me at MasterTheGap.com or consider… Copyright 2013, MasterTheGap.com

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Ø  “The Opening Gap” DVD set ü Two hours on 2 studio recorded DVDs & 1 CD

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www.masterthegap.com/tradingpub Copyright 2013, MasterTheGap.com

HowITradeGaps-030213

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