Opening Gap – Will it hold or will the market retrace?
A reader of this blog posted a question via comment the other day about trading opening gaps in stocks.
What is your advice for trading gap openings? Sometimes a stock will retrace some of the gap and continue to move higher, sometimes move lower.
First let me state for the record that I do not now, nor have I ever been a stock day trader, and I don’t have any expectations of becoming one. That said, I do day trade index futures, and were I to day trade stocks I would no doubt use the same techniques as I do in my index trading.
Corey at AfraidtoTrade.com often discusses gap openings. It’s definitely worth taking a look at what he posts on the subject. I haven’t done the studies he’s done, but I do have some thoughts on the subject from my own trading, which is primarily discretionary.
As noted in the question, sometimes when a market gaps it continues in the same direction and sometimes it backfills. There are a couple of things which can be used to help anticipate which will happen in any given situation.
First of all, if an event (data release, earnings announcement, news headline, etc.) is the main cause of the gap, the timing of that event can provide a clue. If the event was shortly before the open, meaning the market hasn’t had time to fully digest the new information, where the market opens becomes a suspect price, because the market is still trying to process things. It means just about anything could happen, depending on how dramatic the event is. Those sorts of gaps become quite tricky to play. Gaps where the market has had time to sort out the new information are often easier to work with.
Second, what’s the trend? If the gap is in favor of the trend it has increased odds of sticking. One going against a trend has higher odds of getting reversed away.
Finally, where the support/resistance and attraction points relative to where the opening is can be a major indication of what’s like to come. If the market gaps higher but right up to major resistance, then it being held is a low probability prospect. When a gap brings the market within pull of a major market attraction point, then the odds of the market continuing along higher are pretty good (see my price distribution trading course for more information on how I identify attraction points and key support/resistance areas).
As a bit of general advice for someone day trading any market I would strongly suggest focusing very narrowly. To truly be able to guage the likelihood of something like an opening gap fill happening it helps to have the feel for the way the market in question is trading at the point. That can only come from watching it do so. Trying to play a large number of instruments often means sub-optimal performance.
Struggling with support & resistance and knowing what the key market levels are? Check out the Price Distribution Analysis methods I use.
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