Trading the opening gap involves capitalizing on the price difference between the previous day's closing price and the current day's opening price. Traders often look for gaps as they can signal strong market sentiment shifts, offering opportunities for strategies like fading the gap where one might trade against the initial gap direction, expecting a return to equilibrium or a gap fill. I created a tradingview indicator that enhances this approach:
The TradingView indicator is designed for identifying and analyzing daily opening price gaps. It visualizes gaps, calculates the probability of gap fills based on historical data, and provides alerts for trading opportunities like gap openings for short or long entries, gap fills, and custom gap fill thresholds. It includes a dashboard for real-time gap statistics and uses color-coded lines and zones to represent gaps and potential price movements, assisting traders in executing strategies that anticipate gap fill events. See image below of the indicator on the $ES chart.
Entry Strategy for Trading Gaps:
The TradingView indicator is designed for identifying and analyzing daily opening price gaps. It visualizes gaps, calculates the probability of gap fills based on historical data, and provides alerts for trading opportunities like gap openings for short or long entries, gap fills, and custom gap fill thresholds. It includes a dashboard for real-time gap statistics and uses color-coded lines and zones to represent gaps and potential price movements, assisting traders in executing strategies that anticipate gap fill events. See image below of the indicator on the $ES chart.
Entry Strategy for Trading Gaps:
- Gap Size Threshold: Only trade gaps that are 0.50% or smaller of the previous day's close. This criterion helps filter out potentially more volatile or less predictable gaps.
- Position Sizing:
- For Gaps 0.15% or Smaller: Enter with 3 contracts. The rationale here is that smaller gaps might be more likely to fill due to less market momentum, hence a larger position size could be more profitable if the prediction holds.
- For Gaps Between 0.15% and 0.30%: Use 2 contracts. This is a moderate position size, balancing the risk and reward for gaps that are significant but not too large.
- For Gaps Between 0.30% and 0.50%: Use 1 contract. Here, the gap is larger, suggesting stronger initial momentum, so a smaller position size mitigates risk due to the higher volatility and lower probability of immediate gap fill.
Custom % Fill and Target Setting:
- Adjusting for Statistical Probability: The indicator allows for setting a custom percentage of the gap that you expect to fill. Adjust this percentage until you find a point where there's an 80% statistical probability of the price reaching this level, based on historical data provided by the script. This custom percentage becomes Target 1.
- Analyzing Historical Data: Use the script's dashboard to review how often gaps of similar size have filled in the past. If the script shows that 80% of small gaps (let's say 0.10%) have filled by 30%, then your custom % fill for these gaps would be set at 30%.
Exit Strategy for Trading Gaps:
- Positioning Targets:
- Target 1 (Custom % Fill): This is the adjusted percentage where you expect the price to move with an 80% probability. For instance, if you're comfortable with an 80% hit rate, and historical data suggests gaps at 0.20% fill 80% of the time when they reach 70% of their size, set Target 1 at 70% of the gap for a gap of 0.20% or less.
- Target 2 (Full Gap Fill): For gaps that are 0.30% or below, the complete filling of the gap is considered Target 2. This means if the gap is 0.25%, your target would be the close price that created the gap. This full gap fill strategy is applied only to smaller gaps where there's a higher likelihood of complete reversion, based on historical tendencies.
By setting these targets, the strategy aims to capture profits at both a statistically probable partial fill and, where applicable, at a complete gap fill, allowing for two opportunities to exit a trade profitably.
Target Strategy for Larger Gaps:
- Gaps Between 0.30% and 0.50%: For these gaps, the strategy focuses solely on achieving Target 1:
- Target 1 (Custom % Fill): Adjust the custom percentage fill until you achieve an 80% statistical probability of the price reaching this level. This means analyzing past data through the script to find the percentage fill rate at which these gaps have historically been filled with this probability. For example, if analysis shows that for gaps in this range, the price often reaches 60% of the gap size with an 80% success rate, then set Target 1 at 60% of the gap.
- No Full Gap Fill Target: Unlike smaller gaps (0.30% or below), where you might aim for a complete fill, gaps in this range do not pursue a full gap fill due to their larger size and potentially lower probability of a complete reversion to the previous close. The strategy here is more conservative, focusing on a statistically probable partial fill to manage risk and capitalize on a likely market movement without overreaching for a full gap closure.
This post outlines a strategic approach to trading daily opening gaps using a custom TradingView indicator. By focusing on smaller gaps with a higher probability of filling, employing tiered position sizing, and setting precise targets, traders can capitalize on market inefficiencies while managing risk. The strategy leverages historical data for probability assessment, ensuring decisions are data-driven. Remember, while this method provides a framework for trading gaps, it's crucial to consider other market factors and maintain disciplined risk management to adapt to the ever-changing market dynamics.
Volatility does not equal Risk
