The Opening Gap Trading System

The opening gap trading system is a widely used methodology based on sound statistical probabilities. It is highly effective with index, currency and commodity futures and some of the more volatile equities and ETF’s.

Opening gaps are created when an instrument experiences significant trading activity between the close of the market on one day and the open of the market the next day. They are created by news events or highly volatile trading conditions.

The volume and volatility of after hours trading activity determines the size of the opening gap. For example, if sellers step in and drive the share price down significantly in pre market trading, a large gap down will be created.

The opposite applies if buyers predominate between market close on one day and open the next. A large gap up will result.

Why opening gaps can be traded

There is a weight of statistical evidence to show that 70% of opening gaps are filled during that trading session. This creates trading opportunities with a high probability of success, although
it is by no means certain that a gap will be filled and the trader must assess his risks accordingly.

Opening gaps are faded which means that a gap down has a high probability of being filled by buyer stepping in to drive the share price upwards to at least yesterdays closing price.

A gap up is likely to be closed by sellers driving the share price downwards to meet yesterdays closing price.

Because there is a high expectancy that a gap will be filled, you very frequently see a partial gap fill as traders “fade the fade”. What this means is that in an gap down, buyers assume that the gap up will be filled and buy accordingly.

The share price moves upwards towards the gap fill point, however before gap fill is reached, significant selling volume occurs which stalls the upward momentum and then drives the price back downwards again towards todays opening price.

Click to enlarge

You can see an example of an opening gap up in this image. the successful trade in this case was a short at the opening price as sellers fade the gap up. This results in a profitable trade with a high probability of success.

Opening gap automated trading system

Because there are know trade entry and exit points, fading the opening gap is an ideal candidate for an automated trading system.

Risk and reward ratios can be calculated and trade management rules created to develop an autotrader with a high probability of success over time.

The mnGapAutotrader automated trading system trades the opening gap, as we have discussed, and is therefore based on sound statistical probabilities and trading principles.