Gap trading is a simple and linear trading approach in which trading discipline plays a big role. A systematic approach to trading is what is required to trade gaps in price. Gap trading strategies can be applied in daily, weekly, monthly charts but today we will focus on intraday gap trading strategies.
What is a Gap?
A gap in price is essentially a zone where little or no trade has taken place after the close of the previous candle. Therefore a gap appears between the close of previous candle and start of the current candle and the assets price chart shows a definite gap in standard price pattern.
Why are Gaps created?
Gaps in price are created for many reasons. They can occur due to result announcement, important news release affecting the price, simple buying or selling pressure or simple market noise.
Why trade the Gap? – There are many reasons for trading the gap.
- Gap trading is easy – even a newbie in the market can adopt these strategies.
- No need to time the market – you only need to enter a market order at the open.
- The exit is predefined – therefore no need to sit tight on your order all through the day.
- Price gaps occur frequently – hence it is easy to find many trading opportunities.
- Risks are limited – no need to take overnight risks.
- Intraday gap trading strategies work equally well in bull and bear market – no need to predict (!) the next move of the market.
- These strategies can be traded even without the use of charts.
- Strategies can be prepared in very short time – no need to sit and study for long hours after the market closes.
- Gaps have inherent bias and edge. Gaps fill most of the times giving trading opportunities.
- Understanding market bias will lead to trade breakaway gaps giving bigger profit opportunities.
Intraday Gap Trading Strategies
Gaps are either fading or increasing which is known as breakaway gaps. We need to apply strategies for both of these types of gaps with strict stop loss. Long term (10 years data) data analysis shows that more than 70% of cases price gaps are filled up the day they were created. It means you can trade these fading gaps (gaps which get filled up) and have more than 70% winning trades.
For intraday gap trading strategies we look for price gaps in the opening price of the trading day compared to previous day’s closing price. Use our NSE stock screener to look for more than 1% price gap for gap up (opening price = low price) or gap down (opening price = high price). As already mentioned, these opening gaps get filled up on the same day most of the times. Therefore in most cases, trading in the opposing direction of the gaps with strict stop losses will bear fruit. In other cases, the breakaway gap trading will be applied where trading in the direction of the gap will be productive, presuming that the gap will increase. Keeping strict stop losses will save the trader in case the trade goes wrong.
Simple Intraday Gap Trading Strategies For Newbies:
- Look for a stock around 9:20, i.e. after 5 minutes of market open, that has made at least 1% gap upside or downside.
- As discussed earlier, you can use our NSE stock screener for spotting the stocks.
- Buy a stock with a gap down of more than 1%, target last day’s close.
- Short sell a stock with a gap up of more than 1%, target last day’s close.
- In both cases, if targets are not met by end of day, exit trades around 3:15 with a market order.
- Statistically, these trades are profitable 70% of times.
Advanced Intraday Gap Trading Strategies:
- Advanced gap trading uses gap zones. See the image above.
- Look for gap below R1 or above S1 of the daily pivot levels of previous day’s close. A gap above R1 or below S1 has less chance of fading.
- Look for liquid stocks.
- If the opening gap (regardless of the direction of the gap) falls within previous day’s candle body, there is more than 75% chance of filling the gap.
- Following a down day, if the gap falls between previous day low and close, there is 85% chance of closing the gap.
- Similarly, following an up moving day, if gap falls between previous day high and close, there is 85% chance of closing the gap.
- Short at opening price = high price, target 50% of the gap, stop loss = yesterday’s high (presuming other conditions are favorable).
- Long at opening price = low price, target 50% of the gap, stop loss = yesterday’s low (presuming other conditions are favorable).
- Trade along the direction of the gap if opening price > R1, stop loss R1 – 5 points., target 50% of 5-day Average True Range (ATR).
- Trade along the direction of the gap if opening price < S1, stop loss S1 + 5 points., target 50% of 5-day ATR.
- To calculate the high probability of gap trading range – calculate 40% of last 5-day ATR and add with previous day’s high and subtract the same number from previous day’s low – you get approximate gap trading range.
Example Of Intraday Gap Trading Strategies:
Today 9th August, 2017 after market open we checked Axis Bank has made a more than 1% downside gap. The open want not below S1. The open was below the low of yesterday. So we went long with a target of 50% og gap with a stop of S1 – 5 points (check above rule). Axis Bank has done the target of 50% of opening gap within 45 minutes of open.
Thus we conclude our discussion on intraday gap trading strategies. Hope Indian stock traders can immensely benefit from these ideas. We can also use the same logic of gap trading in options trading and trade with hedged position.
Partha, an engineer by education, is theoratically actively following the stock and commodity markets since 1990. He is an active trader since 2003. He has received formal education in future and options and quantum analysis. He is presently working on research oriented projects using Python and data analytics.