Two Rules For Fading Gaps

I wanted to use today's column to address a question that is likely not specific to this reader, as it is a question I get frequently.

"Writers constantly talk about the Opening Range, the Opening Low, etc., yet it is unclear to many/most traders (at least non-professional traders) exactly what is meant by those terms.

"For example, is the Opening Range the range within the first minute, first 5 minutes, or what?

What is the Opening Low? For example, in your 4/24 piece re Amazon, you stated, 'The opening low, $26.40, was breached...the Trigger.' However, when I look at the Amazon chart, the low of the first one-minute bar is closer to around $26.20, not $26.40.  What appears to have been breached was the Open, and it is unclear as to whether you waited until the second bar or entered the moment the Open traded lower (toward the fade) on the first bar."

The opening range is probably going to be defined by different traders in different ways. For me, the opening range, as it relates to fading the opening gap, is the first 10-15 minutes of trading. After that, the likelihood that the market will try to fill that gap or a portion thereof becomes less likely. Yes, it may occur later in the day, but that goes back to trading with standard HVT rules.

So, Rule # 1: Fading gaps should only take place in the first 10-15 minutes of trading. 

However, given that NYSE stocks sometimes do not open until after 9:30 AM EST, we want to make sure that we define the first 10-15 minutes not necessarily from 9:30, but from the time the stock actually opens.

Rule #2: I apologize for not making this clear in the AMZN example. The trigger is typically the opening price. A break above/below is usually the catalyst.

Let's use the same day on AMZN as an example. The stock opened at 26.40, traded up a little higher, then came right back through the opening price. Additionally, you had the S&Ps and the stochastics working in your favor simultaneously.

There is a fair degree of feel built into these trades as well. Many times I will anticipate a break above/below the opening price in order to avoid trying to get filled when the stock hits the "air pocket" which typically occurs on these trades. Like most things, constant observation and practice will sharpen those skills.

For those who are interested, these finer points of trading are what we discuss each day in my Trading Room, an interactive audio feed with myself during the course of the trading day. We discuss entry and exit points, setups and a whole host of the trading-related information. It is not limited to just HVT. I talk about whatever looks like reasonable trade. Click here for more info.

Lastly today, I wanted to share with you a chart that my friend and fellow trading colleague here in my office, Gregg Stein, shared with me.

This chart illustrates what most traders I talk to keep talking about, a correction from this rather frustrating rally over the last few weeks. Sure, like most things in life, when everyone is looking for something to occur, we typically are sorely disappointed. Thus far this has been the case with respect to a pullback/selloff. However, the evidence, which goes back to 1998 can hardly be ignored.

It was only in late 1998 where the combination of a VIX reading in the low 20s, an RSI reading below 30, and an upward trend were not met ultimately by a nice decline. The other eight instances offer those who were paying attention some great trading opportunities.

The important thing is that we cannot sit around waiting for this move. One, you will either go broke, or more likely miss out on good trades in the interim. Like all research, it offers what Derrik Hobbs calls a "Decision Point." A decision point is not the mother of all buy and sell signals, rather it is one piece to the puzzle that we as traders dovetail into our current analysis and then use our bread-and-butter styles and triggers to fully capitalize.

Be patient, this market is no fun for anyone. However, as we found out yesterday in the Trading Room, the rewards go to those who are patient and exercise discipline.

As always, feel free to send me your comments and questions.

Dave