The opening gap trading strategy is a high probability trading method than can bring good returns to the active day trader.
This article will show that this method makes an ideal automated day trading system.
Let's start off by briefly explaining what an opening gap is. It is created when after hours trading activity drives the price significantly far from the closing price. When the market opens the next day, there is a large difference between the price at the start of the new session, and the prior days closing price.
This creates a gap and a trading opportunity with a high probability of success as research has shown that gaps are filled around 70% of the time during that trading session.
Fading the opening gap
To fill a gap down, buyers must enter the market in strength and drive the price upwards so that it travels to, or beyond, the prior closing price. This is called fading the gap and leads to a term called gap fill. The same applies to filling a gap down, although it is sellers who determine this price action.
An ideal day trading strategy
Fading the opening gap makes an ideal day trading strategy. With a high probability that a large gap will be filled during that session, traders can place either long or short trades, depending on the direction of the gap, at the opening price and have a good expectation that price will move favourably for them.
The price action occurs during that session and will either result in the trade being successful or the stops being hit if gap fill is not achieved. The trader should always close his position at the end of the day if neither of these scenarios has been reached.
Why this is ideal for automated trading
The opening gap trade has a number of known parameters that make it ideal for automated trading. The trade entry point is known (the opening price) and the trade exit point is also known – the gap fill price. Also it is relatively easy to calculate the stop loss position which comes into play if gap fill is not achieved.
These known parameters can be programmed into an automated trading system that can then place the trades and undertake effective money management all without intervention from the trader.
This means a number of instruments such as futures contracts can be traded at the same time without the need for a trader to be at the computer screen during the trading session.