We described what the opening gap strategy is in a recent article. Here we show why it makes an ideal automated trading system.
First a quick overview about what the opening gap trade is. When todays opening price is significantly higher than yesterdays closing price, it creates a gap.
Statistical research shows that gaps get filled on the same day around 70% of the time so fading an opening gap presents a trading opportunity with a proven mathematical edge.
Opening gaps have known parameters
What makes opening gaps particularly attractive to traders is that they have known parameters. A lot of trade opportunities are based on market conditions that have far fewer certainties.
These are some of the known parameters of an opening gap:
- The size of the gap, particularly in relation to the previous days trading range (daily high minus daily low prices).
- The direction of the gap
- The price of the gap open and the price of the gap fill
Trading the opening gap
As we know these parameters we can use this information to enter a trade for these reasons:
- We know the direction to trade – i.e. go short to fade a gap up or long to fade a gap down
- We know where to enter the trade – if fading a gap up, go short with a limit order just below the opening price
- We know where to exit the trade – if fading the gap set our profit target at gap fill, yesterdays closing price.
So we have all this known information about our trade before we enter it, which is good trading practice.
Not many trades can be managed with such precision, which makes the opening gap strategy appealing to day traders.
Auto trading the opening gap strategy
Automated trading systems work on clearly defined rules so being able to tightly describe the trade parameters is of importance when designing an automated system.
As we have shown, the opening gap strategy clearly defines when to trade and when to exit. It also creates good money management opportunities as you can clearly define stop loss and move to break even points.
Opening gap strategies are therefore good candidates for automated trading systems as well as being ideal for discretionary trading.
A winning opening gap trade with oil futures today
You can see these factors in our image at the top of this article (click the picture for a full sized image). This shows a winning trade from our automated gap trading system today.
A down gap was created today so the system went long when certain candle conditions were met. The profit target was gap fill at todays opening price. As you can see from the enlarged image, the gap filled and our profit target was met.
The automated system then exited the trade and shut down having made a nice profit today.