Thursday, June 19, 2008

Trading the Opening Gap

The Nifty opened lower today, with a gap of about 50 points from yesterday's close. How do we trade this gap open ? Let us see what some of the technical analysis masters say:
Victor Sperandeo, trader & author says:
If there is a gap, and it is going to reverse, it will do so 10 to 15 minutes after the opening 95 percent of the time.
Larry Williams has a day trading pattern called Oops!. It requires a gap above the previous day’s high / below the previous day's low, that can’t hold. In other words, it fails soon after the gap is made.
The general idea is that a gap begins to get filled soon enough, or not filled at all. I do not think that the gap itself has to get filled in 15 minutes. What Victor probably means is the market should start making an effort to fill the gap, by slowly moving up.
The 15 minute rule.
I follow a simple 15 minute rule in my trading. When there is a gap open, I wait patiently for 15 minutes. Then, if I wish to buy, a buy stop is placed above the high of the first 15 minutes. Or, if I wish to sell, a sell stop is placed below the low of the first 15 minutes. This simple method will keep me away from trouble many times. The idea is: let the market tell me it wants to move in my direction.
Today's gap down
A gap down in the Nifty did not move above the highs made in the early minutes of trading. As the day progressed, this was a message that today's trading would remain under bear pressure. of course, there is no guarantee that prices will remain down. In the markets anything can happen. But the probability is that prices are likely to remain below the highs made early in the day. At least for today, this is what happened. Nifty futures quickly went below 4500, and remained below this level for the rest of the day.
How do we trade the gap open ?
As the day progressed, the highs of the early morning become resistance. This becomes a stop loss for any short entry that is planned. When the market falls sharply and begins to recover, a long position may be taken only if there is some profit possible by selling before the resistance.