Profitable ETF Trading Strategies: trading the morning gaps
There are many trading books from excellent traders that described their particular techniques for trading the morning gaps. If you look carefully at their ideas see that in many cases we are in complete disagreement about an appropriate strategy for the gap. This sounds stranger than it really is.
The morning gaps is so volatile that there are a number of short-term strategies that can make money if execute effectively.
For me, however, the morning gap is so volatile that I like to wait approximately 20 to 30 minutes to get a read on the morning price action before I commit my money.
I conducted several daily analyses concerning the gap, however, that shapes my strategy for the following day.
First, I analyze statistics concerning the science and direction of the morning gap in the market in my target of interest the past 200 days. I uses information to establish normal and abnormal gap, in order to increase my understanding of the current context of the market and the trade. I actually use this information to help me manage my exit decision near the end of the day regarding the size of the overnight risk I am prepared to take.
There are some times when the correlation between the gap and the subsequent follow-through is so strong that you can use the strategy of linear forecasting to estimate the size of the follow-through based on the morning gap. This only happens 10-20% of the time, but when it does it can help you very carefully engineer a good reward to risk ratio trade.
A persistent finding is that the size of the gap correlates strongly to the size of the follow-through. Unfortunately this will not predict the direction of follow-through reliably.
In terms of standard practices and intraday battle drills, I look for a morning hook or a bungee trade in the direction of closing the morning gap when it’s large.
The morning will normally takes the form of a large gap down, the sharp see selloff, intraday support established at the low of the day, followed by a reversal to at least close the morning gap. There are a number of sub strategies with the morning hook but the basic idea is pretty simple.
The bungee trade occurs on exceptionally sharp selloff that begins to immediately rebound on an upward trending day the broader market. In many cases this strategy allows us to front run a mechanical entry price that we have established during our preparation phase.