Understanding Gaps: Profiting from the Opening Gap

Trading gaps is not for everyone. But for me, I consider the opening gap, the ideal trade setup. They occur almost daily, offer plenty of profit opportunity, and are normally short term in nature (1-2 hours). Gap trading offers many other compelling benefits including:

1. Gaps have an inherent bias and edge: over 72% of all gaps in the S&P 500 futures market have filled the same day over the past ten years.
2. They occur frequently (three to four tradable gaps per week in the S&P) so I am not reliant upon catching that “one big winner” to achieve my monthly goals.
3. It’s an easy trade to learn and play. No need to “time” the entry – just use a market order at the open.
4. I can prepare in about 15 minutes before the market opens each day. No need to scan hundreds of stocks at night.
5. I can trade them without charts and from anywhere.
6. Getting filled with minimal slippage is not an issue –especially in highly liquid markets like the equity indices and futures markets (S&P 500, NASDAQ 100, etc.).
7. The target is pre-defined so I don’t have to manage the trade after placing it (though sometimes I do to maximize profits).
8. My risks are controlled and limited to a small percent of my account. No overnight risk.
9. Gap trades work in bull and bear markets equally well. I don’t need to predict the market’s next move.
10. They occur in most asset classes (equities, futures, currencies, etc.) and can be traded using stock, options, and futures contracts.
11. I can grow my account several percent per month on average, and often more with this single, simple setup using just one market. No need to baby-sit lots of different markets waiting for that perfect, entry-sensitive trade to appear.
12. Understanding the bias of the market before and after the gap fills, provides a trading edge for the rest of the day while also helping optimize my entries on swing and position trades.

I am not the only one who recognizes these many benefits. James Altucher, in the first chapter of his book, Trade Like a Hedge Fund, states:

“The gap trade is the bread and butter trade for many day traders and hedge funds.”

The opening gap in the S&P futures is the single most significant daily event in the global equity markets. It is, therefore, arguably the most important trade of the day. Because I trade the E-Mini S&P 500® futures for a living, most of my examples and research are based upon this index. However, the fundamentals of gap trading shared in this book can be applied to gaps in any market.

Contents:

– WHAT ARE GAPS? 

• The Basics
• How To Use & Profit from Gaps
• The Promise of Gaps
• The Paradox

– CREATING A PROFITABLE STRATEGY

• Gap Size
• Gap Zone
• Seasonality
• Stop Size
• Target Optimization

– REAL WORLD EXAMPLES 

• How I Trade Gaps
• Gap Fade Examples
• “Go With” Example
• “Fade the Fill” Example

– GAP TRADING TIPS

Understanding Gaps: Profiting from the Opening Gap By Scott Andrews pdf