How to Trade Gaps with the Odds in Your Favor
I’ve discussed more about gaps and trading them strategically than ever expected to. I also imagine this will be the last go round on that topic for quite some time to come. There are many more little details to be covered, but the big picture is what we need focus on first.
Statistical Probability
Financial markets become more intertwined and global each year. Maybe it’s just me, but seems like almost every day now there is a gap open in the e-mini markets due to overnight movement in sympathy with overseas markets and/or economic data that affects world indices alike. I suppose the only way to apply some measure of science to this would be rolling up our sleeves, peeling back the S&P 500 e-mini charts to count how many sessions in 2009 so far have behaved in what manner.
Figure 1:
Quick study of the charts shows roughly twenty-two sessions, almost all of them so far have opened with some type of gap-up or gap-down move from prior session’s close. Of those in total, five opening gaps went unfilled by the closing bell that same day. In other words, five divided by twenty-two equals roughly 77% of the instances where a session opened with a gap likewise filled that gap intraday.
Figure 2: 02/04/2009 ES 10-Minute Chart
Some of those gaps were rather narrow, some large. Some of those gaps quickly closed while others remained open for hours. A few of them looked highly improbable from the (myopic) morning view to be closed later that day. Doesn’t matter… statistics are all the same. February 4th is a good example of such. Gap & go morning rally seemed destined to hold high ground from there. Those who know and understand the high-probability patterns of repeated behavior in markets knew enough to expect that gap close as highly probable. They weren’t disappointed… at all.
Summation
Some days have certain situations that are more predictable than others based on pure statistics alone. Unskilled traders make themselves believe that random chaos rules price action. Not true. A poor carpenter always blames his tools. The more learned and skilled a trader becomes, the greater degree of orderliness and predictability they see in measured price movements. Open gaps are merely one of numerous ways to keep yourself on the correct side of high-probability pending price direction. We can expect gap-open events to become the norm, and sessions without a gap to be unusual as global markets continue to meld. Knowing some of the high-odds characteristics to these events enables savvy traders to profit from repetitive patterns in the market.
Austin Passamonte is a full-time professional trader who specializes in E-mini stock index futures and commodity markets. Mr. Passamonte’s trading approach uses proprietary chart patterns found on an intraday basis. Austin trades privately in the Finger Lakes region of New York. Click here to visit CoiledMarkets