Understanding The Odds:
Trading The Opening Gap in the Mini Index Futures Contract
This article describes just one of the many high probability trading setups included as part of the JumpStart One-On-One Mentoring Program, a powerful new series of indicators and a dynamic mentoring program designed as a jump-start to successful day-trading in the Index Mini Futures contracts. Click Here! for more information on this exciting new program.
To view the 8 minute video presentation on the Open Gap Trading Technique recently made at the Dallas chapter meeting of AFTA, click on the link below. Be patient - the file may take 5-10 minutes to fully download. For multiple viewings save the file to your hard drive, then double click to start. Click Here!
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Many active traders regard the futures markets as unsuitable largely due to an assumption that the endeavor requires massive amounts of time and energy. It is true that effective full-time trading DOES require a serious commitment. But an initial introduction does NOT require the participant be "chained" to a computer screen all day. Effective trading can, and for many successful traders, does consist of employing only one or two very high probability setups that regularly occur during specific time periods of the day. These are traders who have done their research, they fully understand the odds behind their methodology, and they execute their trades in a very disciplined fashion. The purpose of this article is to explore just one high probability setup that normally occurs within one specific time period of the trading day - that of the opening gap.
An opening gap occurs when the market begins the trading day at a price other than where it closed at the end of the previous session, resulting in a "gap" in price when viewed on an intraday chart. If this discrepancy is unusually large, it is likely that new information has entered the marketplace, and price activity will tend to trend even further in the gap direction. If the difference between closing and opening price levels falls within a more reasonable range, there will be a tendency for the market to trade back into the gap area. The strength of this tendency is indirectly proportional to the magnitude of the gap. The narrower the gap, the stronger the tendency. Very small gaps are not even tradable. Very large gaps are less likely to close, and contain the potential to quickly move even further away from the gap level, marking the beginning of a strong trend move. These kinds of gaps are referred to as "Breakaway". On the other hand, the kind of gaps that have a higher probability of closure, and the sort that we are most interested in for the purposes of this article, are referred to as "Common" gaps.
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There are no hard-and-fast rules that determine one gap a Breakaway and another Common, but a few general guidelines can be used to help differentiate between the two. The fist is time-based. If the opening price on a gap to the upside stands as the low after the first 30 minutes of trading, the gap will most likely be of the Breakaway kind. And, on a downside gap, if the open remains the highest price traded within the first 30 minutes, there is a high likelihood that the gap is of a Breakaway nature. Another consideration is the magnitude of the gap. An opening gap level that falls below the levels noted below can generally be regarded as Common. Gap levels that are greater than the ones noted below can be thought of as Breakaway. If a gap level falls between the two we can think of it as having an equal chance to develop as either Common or Breakaway. Remember that these levels are to be used only as a very rough rule-of-thumb. They are relevant at the time of publication, but may vary to some degree with changing market conditions.
|Gap Size Guidelines|
|S&P 500 E-Mini (ES)||< 4.00 points||> 7.00 points|
|Dow Jones Mini (YM)||< 40 points||> 70 points|
|Nasdaq 100 E-Mini (NQ)||< 10.00 points||> 18.00 points|
|Russell 2000 E-Mini(ER)||< 2.00 points||> 3.50 points|
A third method used to differentiate between the two is based on NYSE Tick readings. The Tick is provided by most intraday day data providers and represents, at any given moment, the number of stocks trading higher on the NYSE minus the number of stocks trading lower. A positive reading is bullish, as it represents a greater number of issues increasing in price, whereas a negative reading is bearish. An opening gap to the upside that cannot exceed a NYSE tick reading of +300 within the fist few minutes of trading is generally considered to be of a Common nature. On the other hand, an upside gap that occurs on a tick reading greater than +300 and climbs as price climbs can usually be regarded as Breakaway. Alternately, a downside gap that does not drop below -300 within the fist few minutes can be considered Common, while one that occurs on a tick reading below -300 and drops as price drops can be considered Breakaway. Again, it is emphasized that these parameters are best regarded only as a rough rule-of-thumb, and should not be used in mechanical fashion. Think of them simply as extra bits of information that assist in interpreting internal market dynamics.
In addition to the guidelines mentioned above, there are a few other market variables that we want to take into account before the start of the trading day. These considerations aid in determining the likely nature of trading activity in the early hours, and helps us to decide whether the opening gap (if one exists) is likely to be tradable. First off is a review of Trin (sometimes called the Arms Index in honor of its developer, Richard Arms). This is a breadth oscillator designed to measure internal market strength, and is most often provided as part of a real-time datafeed. Although a modified version of Trin is preferred in that it delivers more detailed information and is far easier to read (which is especially important during fast-paced, hectic trading conditions), the levels noted here reflect the standard Trin, which will be more easily accessible for most readers. A closing prior day Trin reading near or above 2.0 tells us that the day ended on an excessively bearish tone. If overnight pricing has not already swung to the upside, we can usually expect it to do so in the very early part of the trading day. Once this excessive bearish pressure is released, further downside typically follows. On the other hand, if prior day Trin finished near or lower than .5, we know that the day ended with excessive bullishness. A push lower should occur either in overnight trading or early the next day. Once market tone is effectively neutralized further upside normally ensues.