[jasont]

In my journal I made this post in regards to research I did on the opening gaps. It was recommended that I post a thread in here to get the alternative views on the topic as it has probably been investigated by people here before. Here is the post below with my research:

As I have been noticing some big moves at the open I thought that it might be a good idea to see how I could capitalize on these moves. At first I thought there was a connection between where the Tick opened and where the market subsequently traded for the morning.

Following that basis I decided to research the Tick and the open to find what the real result was. I managed to get 33 days of data to form my analysis on. It began from 17th March 2008 and went to 6th June 2008. Its not a massive amount of data to use but I'm not forming a mechanical trading system. I simply want to find an edge that can be used in conjunction with my interpretation of the market.

During that period there was 21 negative Tick opens versus 12 positive ones. On 20 days the Market initially moved in the direction of the Tick and 13 times the market moved against the Tick straight out of the gate. That was promising until I looked at the values the market moved. When the market moved in the direction of the Tick it averaged 3.21 points. The average move the market made against the Tick before going the direction of the Tick was 1 point.

This was ok but I didn't like the ratio. I looked further into different relationships between whether the market opened positive or negative and if the Tick followed suit. After some searching I came to opening gaps.

I found that 22 of the 32 gap days we closed the opening gap. My definition of a gap was having an open 0.25 above or below the previous close. Closing of a gap I defined as reaching the high or low of the last 5 minute bar the day before. I thought this was interesting as it sort of went against the Tick relationship yet still had a 60% success rate.

I would have suspected that had we opened down we would get a negative Tick reading and vice versa. To close the gap would be going against the Tick reading.

Now I had a mentor that traded the close of an opening gap and mentioned some days were better than others and the size of the point gap also mattered. I have found that Wednesday and Thursday were the most reliable to close the gap. I also found that a gap over 8 points would rarely be closed. In fact only 1 in 6 gaps over 8 points were closed. If I removed these 6 big gaps from the data, we would only have 26 gap days and 21 of those were filled. Now that seems like a decent edge.

Concerned as some of these gaps were only small, I wanted to find out what the size of these moves were. Considering the 3-1 ratio the Tick idea presented I wanted something pretty solid. So I recorded the size of the move that closed the gap and also recorded the size of the initial pullback prior to closing the gap. So say we gapped down 4 points to 1390 and moved down to 1389.25 before moving up to 1396.50 and coming back. The initial pullback size was 0.75 and the size of the move that closed the gap was 6.50.

The results were pretty darn good. I found the average size of the move when we closed the gap was 5.60 points whilst the average size of the initial pullback was 0.67 points. The biggest move when closing the gap was 12 against the biggest pullback of 1.75. The lowest move when closing the gap was 2 points whilst the lowest pullback was zero.

Now if I limited this to only trading gaps below 8 points I would possibly make a profitable trade of 1.75 points on 21 trades whilst losing a maximum of 1.75 points on 5 trades. I decided to look further at which days tended to close the gap more than others. For specific weekdays, the ones which closed the gap most commonly were Thursdays and Fridays. The ones which performed the worst were Mondays and Tuesdays. Funny as these were the same days my mentor mentioned to me a long time ago.

Of the 6 Mondays, 3 closed the gap. Of the 8 Tuesdays, 3 closed the gap. Of the 6 Wednesdays, 6 closed the gap. Of the 8 Thursdays, 7 closed the gap. Of the 5 Fridays, 3 closed the gap.

From here, if I removed the Tuesdays and Mondays as well as gaps above 8 points, these are how my stats pull up.

Total Gap days excluding Mondays, Tuesdays and moves above 8 points: 17

Total Days Gap Was Closed: 15

Ratio of Days Gaps Closed: 88%

Average Size Of Gap Move: 5.95

Average Size Of Pullback before Gap Move: 0.70

This has been very interesting. There was no strong relationship between upward and downward gaps that were reliable. I will now look at paper trading this though from these numbers this seems very much a good way to trade some of the opening days. The ideal way to do this would be getting a trade as close to the open price as possible with a stop 1.5 points away. The first profit target would be placed at 1.75 level and then using the second position to trail.

Although this limits me to only trading the open during the second half of the week, it does keep the edge in my favor.

[MC]

Interesting...subbed.

The only part I don't get is the 8 point or larger...this is the ES I presume and not the YM correct?

[jasont]

Yeah sorry MC. The gap is for the ES. What does subbed mean?

[MC]

Originally Posted by jasont »

Yeah sorry MC. The gap is for the ES. What does subbed mean?

Subbed means...Subscribed to see what you or others report on gaps.

So from your studies middle of the week is the time to fade it seems.
I'm curious of any psychology behind the gap moves if you guys have thoughts.

On stocks they use gaps to keep you out of the move often, not really the case here. I know gaps on indices tend to be like black holes when weakness is shown and they gravitate to filling the open gaps. Kind of like how virgin POC tend to be tested at some point.

Just throwing some random thoughts out.

[jasont]

Hey MC thanks for the replies and interest.

Now I am not sure why Wednesday and Thursday tend to be the better days. Maybe the market gets an idea of fair value later in the week. I will try to outline my thoughts on the psychology behind it as best as possible but think others will come up with some good ideas also.

I think the market is ruled by the big players. Lets say we look at yesterdays range. We began a decline in the afternoon. Some of the big players may not have been willing to get on until we saw a breach of the 1350 area. If we gap down to the 1350 they will be banking on one of two things happen. We go beneath the 1350 support area or we bounce off it.

If they see a breach of the support coming, they want to get the best position possible. The big players begin buying up light and selling bigger to the following thinking the market is bouncing. Trying to get the best possible entry. Market goes up and closes the gap. Then as we come back down and breach the support they can start unloading their big positions on the way down as average Joe trades the breakout move.

If they see a bounce from support coming they may buy straight from the gate or have worked up their position during the pre market. They may even try to push the market down a bit over the support area to buy the breakout traders. The ES commonly tests the support and resistance levels to run a few stops and gain position.

Just some ideas behind the psychology I came up with. Hope to see others with ideas as to why this may occur or may not continue to occur.

[firewalker]

Nice idea to open a thread for...

I thought I'd just copy my original reply from your blog here, just in case anyone else want to follow the discussion with these things i mind:

Several comments:

(a) [starting a new thread, which has been done]

(b) Don't forget to take into account the news that often is released 30 minutes after the open.

(c) Traditionally there are four types of gaps: common, breakaway, continuation and exhaustion gaps. See also here: http://stockcharts.com/school/doku.p...ool:glossary_g

(d) What might be more significant in trading gaps, is to determine whether or not the gap means a break of important S/R. This might help in determining the probabilities of a move in the same or opposite direction.

(e) In futures because of the overnight trading there is technically no gap as everything is pretty continuous and markets can be traded 20 hours out of 24...

I was wondering if anyone else played with gaps? Because in general, they do have a tendency to get filled...

[firewalker]

Originally Posted by MC »

So from your studies middle of the week is the time to fade it seems.
I'm curious of any psychology behind the gap moves if you guys have thoughts.

Although I've never given it much thought nor attention, I have read (and observed some things in my -relatively short- trading career):

Fridays then tend to be difficult days, especially after lunchtime.
Fridays tend to be trend-following (it was especially true last year, when we had the parabolic rise). In bear markets, Fridays then to be the days when not a lot of people want to be long...

To determine whether there is any correlation with gaps being filled or not on certain days, I think you'll need a whole lot more stats than just 20 days for that.

[jasont]

FW those are some interesting findings on Fridays. I think what I find most interesting is that for a long time it has also been said people tend not to hold long positions over the weekend. I wonder if that is a phenomenon brought on by the news during the weekend prior to 1987. Maybe people have decided the weekend risk is too high in general?

I agree that 20 days is hardly enough to go by for solid analysis. I would love to have at least 50 days analysis for this type of thing. Unfortunately I don't have access the the backdated data. If anyone is willing to do a check, I guess mainly of Wednesday to Friday I wouldn't object.

I guess for me the most interesting part is of 32 gap days we had 22 gaps closed. That alone is a high ratio of 68%. There has been a long time belief that gaps had a tendency to be filled in the market but only now have I done any solid research into it. If we include the gaps from Monday and Tuesday this week, Wednesday didn't gap in my analysis, we have 24 of 34 gap days filled. Bumps the ratio up to 70%.