Gap trading strategies introduce specific methodologies and approaches when buying or going short on stocks. The main idea is to find an asset with a price gap when compared to the previous closing price. The next stage is to identify possible trending ranges within the first hour following particular buy (when the price rises above the range) or sell (when the price falls below the range) signals.
In this article, we will try to explain what gap trading is, what types of gaps traders may use for their strategies, and how successful the approach can be.
What is a gap? It is the price difference between closing and open day levels. As a rule, the majority of guides and technical analysis tutorials offer only four baseline gap patterns that involve:
In reality, you will have to deal with more gap types and classifications we will describe in detail a bit further. Otherwise, it will be hard for you to gain success when utilizing common gap trading strategies. Under real market conditions, you will have to choose between at least 8 different gap configurations depending on their specific criteria. Although major gap classifications include mainly Full and Partial gaps.
To make the most of the approach, you need to consider the following types and strategies accordingly:
Full Gap Up Long
If the opening hour offers a higher stock price than it as the previous day, it the sing to go long or open a buy position. A good idea is to use the 1-minute chart and set a stop-loss order one tick above the price’s high.
Full Gap Up Short
If the buying pressure is insufficient, the price of the stock is very likely to go beyond the opening tag or at least stay on the same level. Traders will have actually similar signals to the previous situation. However, this is where they are supposed to go short or sell assets. Once again, you will need to revisit the 1-minute price chart, identify the price low during the opening trading hour, and set a short stop two ticks below that low.
Full Gap Down Long
Gap trading requires much research, as 2even the slightest bad news, a company’s re-structurization, or decline earnings can result in a stock price drop. This particular gap type identifies the price that was lower not only the previous day but also the day before. As a rule, such stocks tend to climb up during the first hour of the next trading day. Some experts call it “dead cat bounce”.
Full Gap Down Short
If the price drops lower if compared to the previous day’s level, you should place a short stop two ticks below that low achieved during the opening trading hour. Just as before, the 1-minute chart used after 10:30 a.m. may come in handy.
Now, you know all variations of full gap types and trading tactics. The next group involves partial gaps that may also include long and short gap ups and downs. The key difference between full and partial gaps is increased gaining possibilities as well as bigger risks involved.
While full gap stocks generally move in the same direction over a longer period of time, partial gap stocks can be quite hard to predict. This is what makes partial gap trading a bit riskier. At the same time, potential profits can also be higher. Those who opt for partial gap strategies should trade with greater attention to details and price moves. Additionally, we recommend placing closer trailing stop-loss orders of somewhere between 5% and 6%.
Partial Gap Up Long
Always keep an eye on the stock price during the opening hour. If it is higher than the previous day’s closing price but not higher if compared to the previous day’s low, the condition is identified as the partial gap up. The process of entering with a long position is similar to the one for Full Gaps.
Partial Gap Up Short
With partial gap up short conditions, you also have to do the same as with full gaps. Use the 1-minute price chart, identify the price low during the opening trading hour, and set a short stop two ticks below that low.
Partial Gap Down Long and Short are also traded the same way as we have discussed earlier.
The success in gap trading is the question of discipline, greater attention, and permanent research. One should always stay in touch with the company’s news, revenue data, and other crucial criteria not mentioning stock price levels. The good news is that some strategies provide enough flexibility. Traders can apply them to different timeframes, not only intraday trading but also other types of short-term techniques. They can be used for weekly or end-of-the-day sessions as well.
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.