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 the previous candle and the start of the current candle and the assets price chart shows a definite gap in standard price pattern. GAP = Today’s Open minus Yesterday’s Close.
Why are Gaps created?
Gaps in price are created for many reasons. They can occur due to result announcements, important news releases 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 a 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 the 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 time. 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 one stock around 9:20, i.e. after 5 minutes of market open, that has made at least a 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 the day, exit trades around 3:15 with a market order.
- Statistically, these trades are profitable 70% of times.
What Is Gap Zone?
- If yesterday was a UP day and today market opens above yesterday’s close (i.e, gap up), then there is 85% of chance that the gap will be filled today.
- If yesterday was a DOWN day and today market opens below yesterday’s close (i.e, gap down), then there is 85% of chance that the gap will be filled today.
- Suppose, yesterday was a UP day and today market opens between yesterday’s open and close (i.e, gap down), then there is 75% of chance that the gap will be filled today.
- If yesterday was a DOWN day and today market opens between yesterday’s open and close (i.e, gap up), then there is 75% of chance that the gap will be filled today.
How To Trade Gaps At Opening?
- We will go with the 85% accurate rules of gap trading.
- Look for a stock or index with a strong UP day yesterday. If it opens gap up today, short sell at open. First target 50% of gap and final target full gap fill or gap fade.
- Look for a stock or index with a strong DOWN day yesterday. If it opens gap down today, buy at the open. First target 50% of the gap and final target full gap fill or gap fade.
- The stop loss can be at your discretion. If you have a 1% gap, your SL should be at least 0.5%. Hence the more the gap size the more the chance of profit. Let’s check with an example of how to trade gaps at the opening.
- You can find stocks or indices with more than 1% gap in our NSE stock screener page.
Example Of Gap Fading:
On 16th August 2017 Nifty had strong rally throughout the day and closed UP at 9897.30. Check the end of day chart of the Nifty index below.
So it was a UP day. The next day, i.e, 17th of August, 2017 Nifty opened a gap up at 9945.55. So it was a gap up of 9945.55 – 9897.30 = 48.25 points. As per the rule, yesterday was a strong UP day and today is again a gap up, so we short sold the Nifty index in either future or bought puts.
Check the image above how the gap got filled before 11:30 AM. A net profit of 48.25 points or an intraday profit of 48.25 x 75 = Rs. 3618.75 per lot size of 75 in Nifty. This was a typical example of how to trade gaps at the opening. You can also try buying the stocks at open on gap down after a strong DOWN day. I will be happy to answer your comments in this regard.
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 the 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 the previous day’s candle body, there is more than a 75% chance of filling the gap.
- Following a down day, if the gap falls between the previous day low and close, there is an 85% chance of closing the gap.
- Similarly, following an up moving day, if gap falls between the previous day high and close, there is an 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.
More Example Of Intraday Gap Trading Strategies:
On 9th August 2017 after the 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 along with a target of 50% of gap with a stop of S1 – 5 points (check above rule). Axis Bank has done the target of 50% of the opening gap within 45 minutes of open.
How to trade gaps in a volatile market?
The key to success is identifying correct trend direction, then enter in a pullback in the direction of the trend and then finally ensure quick profit booking to lock in gains.
We recommend ZERODHA as a broker for quick profit booking. One may check our ZERO BROKERAGE CLUB page to avail of special benefits for ZERODHA clients.
Scott Andrews 12 Reasons To Trade Gaps
The GURU of gap trading is Scott Andrews, The Gap Guy. He has his famous 12 reasons to trade the gap. They are as follows:
- Gaps have an inherent bias and edge: over 72% of all gaps in the S&P 500 futures market have filled the same day over the past ten years.
- They occur frequently (three to four tradable gaps per week in the S&P) so I am not reliant upon catching that “one big winner” to achieve my monthly goals.
- Gap trading an easy trade to learn and play. No need to “time” the entry – just use a market order at the open.
- I can prepare in about 15 minutes before the market opens each day. No need to scan hundreds of stocks at night.
- I can trade them without charts and from anywhere.
- Getting filled with minimal slippage is not an issue –especially in highly liquid markets like the equity indices and futures markets (S&P 500, NASDAQ 100, etc.).
- The target is pre-defined so I don’t have to manage the trade after placing it (though sometimes I do to maximize profits).
- My risks are controlled and limited to a small percent of my account. No overnight risk.
- Gap trading works in bull and bear markets equally well. I don’t need to predict the market’s next move.
- They occur in most asset classes (equities, futures, currencies, etc.) and can be traded using stock, options, and futures contracts.
- I can grow my account several percent per month on average, and often more with this single, simple setup using just one market. No need to babysit lots of different markets waiting for that perfect, entry-sensitive trade to appear.
- Understanding the bias of the market before and after the gap fills, provides a trading edge for the rest of the day while also helping optimize my entries on swing and position trades.
My Gap trading rules
- Don’t trade breakouts. A fake breakout can happen
- Watch the breakout of the first half an hour. The breakout of the first half-hour can set the mood of the day.
- If the breakout of the first half-hour is on the upside never try to short the market till 1:00 PM. Rather try to buy in dips of the RSI indicator. Sell in rallies of stochastics or RSI.
- If the breakout of the first half-hour is on the downside never try to buy the market till 1:00 PM. Rather try to short in rallies of the RSI indicator. Cover in dips of stochastics or RSI.
This till 1 PM trading style is called lunch trick and works almost 80%-90% of times in gap days. Check the image above for more clarification. For any further queries, I will encourage comments below the post.
Thus we conclude our discussion on intraday gap trading strategies. I 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 a hedged position.