What to do when price gaps beyond entry on the open

Today forced me to look into strategies dealing with price gaping up or down beyond the planned entry price.

In my search I found this site.  Morpheus Trading Group – a financial website offering information on technical trading including picks, and an educational section.  Digging around the site I found this article pertaining Gap trading.

In a nut shell it states:

  • If the price gaps up or down 1% past the intended entry price put the buy on hold until an appropriate low risk entry is formed (I.E: a pullback).
  • If the price gaps up or down less than 1% past the intended entry price, buy on open with a market order.

Another notable advice deals with trading ETFs.  They talk about a five minute rule, whereas on the open if a price would immediately trigger an entry, they advise to wait until 9:35 AM to enter the trade in order to avoid rogue trading action.   Furthermore, they say that if a price is beyond the trigger price and then it pulls back behind it then they enter the trade at the original target.

Finally they discuss the scenario where the price gaps beyond an intended stop price on the opening.  They advise to set a new stop 15 cents beyond the new low of the first 5 minutes of trading.  If after 5 minutes the price is trading beyond 1% of the original stop price, they set a stop 15 cents below the low of the first 20 minutes.

All of this goes along with my personal strategy, except that I usually use 10 minutes instead of 5, and I also apply it to stocks.  I find that the opening action is usually an aberrant in regards to the rest of the day’s action.  It’s very easy to be shaken out by the whipsaw action of the first 5 to 10 minutes.  Also I tend to use a stop that changes depending on the price levels of the stock that I’m trading.  15 cents is a lot for a $6 stock but insignificant for a $300 stock.  I simply multiply the level by 0.0025 and subtract the result to it to determine my stop.  For example if my stop is 81.92 it would be (81.92 * 0.0025) – 81.92 =  – 81.72.  So a 20 cent stop to 81.72 would be in order.  The same calculation applied to a lower priced stock at 9.75 would be (9.75 * 0.0025) – 9.75 = – 9.73.  A 3 cent stop here.  This accounts for the different volatility at various price levels.  More on this in a separate article in the future.

Another site – Nyse-Trade suggests to place a new entry if the price breaks out of the range formed in the first 30 minutes.  This is a more conventional gap trading strategy where most traders using such use either the first 30 or 60 minutes of trading to establish a range.

Entry size must be adjusted to compensate with the added risk when using these strategies.  Also depending on the technique and time frame I would use a trailing stop until a proper level is established.

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