Trading Gaps and Breakouts (Stocks)

B

Brandonf

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Using gaps correctly can provide a very nice and steady stream of profits to traders. In most cases a gap is an emotional event, the bigger the gap the more emotion there will be tied up in it. When ever there is a situation in the market were the majority are acting emotionally (generally irrational) there is a good opportunity to make money if you already have a plan in place and stay cool.

In late August I started a thread to share info about trading the Emini's in relation to the direction and amount of the days gap. (http://www.elitetrader.com/vb/showthread.php?s=&threadid=8127). A lot of the info from that is used here as well. When I had this thread active there was a good amount of interest in it and I have talked to a number of people who have been able to take the info and run with it nicely. Given that interest I thought I would start up another thread - this one with more of a focus on equities. I will try to post a few examples and real time idea's each week so you can get a good idea of the method.

Brandon
 
Attatched is a chart of Analog Devices (ADI) from Feb, 14 (Friday) showing a trade I took and the alert as it was presented.

The difference between Thursdays close and Friday's open was +$0.97. This is a rather large gap. One thing that is important to always have in mind when dealing with gaps is that the larger the gap is the less likely it is to fill in (on the day it occurs). This does not mean the stock will not move lower, so I don't ever just buy because of the gap, but the gap gives me something to look at. The general rule for gaps is that there will be some filling in, even on the bigger ones, but you can see on the chart of ADI that it did not fill in. This is a HUGE signal to us that the stock is very strong and warrants our further attention. Stocks not doing what they "should" often do the opposite, which in this case is to go up more. Throughout the morning trading period ADI continued to move higher and was one of the strongest stocks in the SP500, this keeps it on my list as a stock to watch later. Its very important though that the stock have a period of rest before I would do anything with it. The reason for this is that I don't like to jump in near the top in an overbought stock. The resting can occur by either price or time. Those that occur by price tend to form very clear flag patterns, those that rest with time do so by trading sideways and forming a base. Advanced Devices formed its base for a couple of hours. After it had rested and we got out of the lunch time doldrums I simply bracket the base and am willing to buy a breakout above the high.

Brandon
 

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Someone commented to me that friday was a special day and showing a long trade taken on friday does not show the validity of said methodology, blah blah blah. Also that I was reckless in buying such and overbought stock in an overbought market yadda yadda ding dong.

So I will do this one step at a time. Obviously one trade does not make a method successful any more than one day or even one month does. Anyone who has been around the block more than once can tell you that. That's why I will continue to post here for some time showing trades both before and after they occur. My hope is that with this information, information I have previously given, info that is available here on ET and elsewhere along with your own experience (this one is probably the most important) you can trade with this and do it well. I have been able to profit from it for a long time and if you develop your eye for it I think that any one can improve their results.

Next we were so very overbought and I bought an overbought stock too boot and I was irresponsible to be buying anything Friday afternoon. First I had a very nice morning, and when I have a nice morning provided that there are setups in the afternoon I am almost always willing to risk some of that profit for the chance to have a nice afternoon and perhaps a great day. Second about "Overbought". This is about the dumbest concept that people ever fall in love with and has probably resulted in more lost money in the market then anything else. Nothing is so overbought that it can't get more overbought in any given timeframe, and second with in this point markets exists on more than an intraday level. That means that maybe the intraday is overbought, but maybe the daily is oversold? Generally the bigger timeframe will win. In general too there are a number of things you could see in the general market on Friday that would indicate to you that we would rally into the close. The purpose of this thread is not to discuss that, but in general we had very strong TICKs most of the day, very good volume and market breadth and a declining TRIN that was showing strong buying interest all day. When this happens usually the move continues.

Anyway, I will post more stuff here and hopefully it will be useful.
 
brandonf
I think it is necessary to state at least once that there is one very simple explanation why bigger gaps do not close wit the same probability as small ones: larger price moves within the same time are less likely than bigger onces. thus if I say a gap of 1.0% closes with significant smaller probability than a 0.5% I could as well say: a price move within the same time of 1.0% is less likely than one of 0.5%.

IMO this is important since it puts some different light on probability statements on gap closings. Probability statements of that kind tend to make people think they are tradeable, which they are not necessarily.

One other thing: in your thread on NQ gaps you mentioned that the average gape since 1990 was about 1.35%, or something like that - I do not remember exactly. I calculated that on my own and looked at the time series of that average gap. this time series is far from being constant, meaning that from the moment you posted until I recalculated it the average gap had already changed by 0.2% - quite a significant shift.

Sorry if I am incorrect.


peace
 
Quote from Brandonf:

Someone commented to me that friday was a special day and showing a long trade taken on friday does not show the validity of said methodology, blah blah blah.
More...


well duh, picking out one trade when the entire market (give or take) exhibited the exact same price action obviously does nothing to demonstrate said methodology...

i guess business must be getting a bit slow...
 
Agree, gaps and breakouts generally provide the best trading opportunities. I also prefer to do most entries when the nas composite is outside of the previous day's high/low ..

ken
 
Brandon,

You have an excellent trading plan, and have an understanding of intraday trading that is far beyond the understanding and capabilities of your critics.

It is funny that people still hang on to that concept of oversold and overbought. They still have not learned that the markets are capable of doing anything at anytime.

People, stop trying to tell the market what to do and start letting the market tell you what it wants to do. When you have mastered that concept, you will start to be a consistent winner in the markets.

CharlesTrader
 
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