Trading Morning Session After Significant Gap: Trader Beware

[Dogpile]

gap down
high made first
trades 'high to low' (diagonally down)

Now 3 straight 'high to low days' --- looking for 1 'low to high' day tomorrow... we'll see.

[steve46]

Hello folks

Gap days are pretty straightforward if you have the right context in which to operate.

Here is one method that works fairly well.

1.) Wait for the open and calculate the spread between the previous session close and the high of the current session's opening bar (use 5 minute bars or candles).

2.) Determine the midpoint of that spread and place a horizontal line at that price

3.) Place a horizontal line through the opening bar (5 minute bar or candle).

4.) Put in your standard pivots (daily, weekly, monthly).

If the open is above the daily pivot, look for long entries above the midline of the opening bar or candle.

If the open is below the daily pivot, look for short entries below the midline of the opening bar or candle.

Just speaking for myself, I find that trading is all about "tests". Price will test the midline of the opening bar, or it might run as it did today (Tues Sept 4, 2007). The task is to determine whether price will "take out" a price point or "fail", and then act to trade that move.

Attached you will see a recent example

As you can see, price opened above both the daily and weekly pivots. So I would be looking for a long entry. The first opportunity to enter long comes right after the open. As you can see, price oscillates between the midpoint of the opening candle and the midpoint of the gap "spread". In my view there are two (2) nice long entries available. The first at 7:20am PST, and the second at 8:10am PST.

[steve46]

Unfortunately the site wouldn't permit me to attach another chart to my first post, so I will do so here

As you can see the first and second long entries are annotated

The second long entry resulted in a nice gain of more than 10 ES points.

At least in my experience, this pretty common (waiting for a second entry and holding for a test of R2)

[OAC]

Thanks for your excellent contribution.
According to the above chart, the two entries are below the Midpoint
of opening 5-min candle. I thought your rule #4 said: If the open is above the daily pivot, look for long entries above the midline of the opening bar or candle.
So my question is when do I make the exception ?

Thanks

[steve46]

Yes, thanks for pointing that out. The error is mine. The line should read look for "long entries as long as price is above the daily pivot".

[steve46]

This morning's session (Sept 5th, 2007) provided a nice example of how to trade a gap down.

As can be seen from the attached chart, the ES contract opened below the daily pivot. Therefore we look for short continuation entries.

One thing that should be mentioned. It is always mandatory that the trader be aware of pending news. Economic reports for instance often hit the market at 7:00am PST. Today the pending report was new home sales which came in down 12%. We observe two (2) things about this. First, the report always leaks to institutional players first. They tend to hedge positions in the options market first due to size constraints and to put on outright positions just prior to the release. This causes what I characterize as an "impulse" move (a quick move of several points duration). Even if a retail trader has a correct limit order in place, often they will fail to get filled unless they act pre-emptively (market order or get filled prior to the release).

As you can see from the chart, early entry at 6:55am PST (1479.25) would have been best. Trying to enter on the open of the 7:00am PST bar (1478.25) would have also worked, but you risked being left behind as the market traded through limit orders. My primary profit target was S1 at 1472.25.