(Reprint of December20, 1993 Article*)

A Day-Trader’s Dream 

OOPS!

y years as a trader have convinced me that The GAP TRADE is a method which fits all of the the more input a trader has in the formation important requirements of a day-trader. I was of a trading decision, the more likely that originally introduced to the GAP TRADE by Larry the decision will be wrong. While this may not Williams who deserves all of the credit for it. Larry sound right, the fact is that it IS right. Traders cannot called it the OOPS signal for reasons which I’ll help but have their wishes, emotions, expectations, explain later. I call it simply the GAP TRADE. fears and dreams interfere with decisions. Hence, the more a trader thinks about a The rules of application are TRADE, the more a trader simple indeed. But before Gap Trades – Buy and Sell Signals “analyzes” a trade, the greater deatiling them I’ll define SELL SIGNAL BUY SIGNAL the probability that the trade what I mean by a GAP. In Buy on a stop 2 Gap Up Opening will be a loser. I do not mean tics above this this case we are dealing with low. Exit at stop to denigrate the importance of an OPENING GAP which is loss or on market the trader, yet the facts are the on close. the first condition for entering facts. a gap trade. Sell Short on stop
2 tics below this high . Exit at stop Unless you’re an exceptional loss or on market trader, you’ll find that the on close. more you spend in thought, the less you reap in profits! Traders don’t need complicated systems, they need simple systems that don’t require a GREAT deal of judgement or thought. This is especially true of daytrading methods.

Gap Down Opening

Some day-traders are addicted to their quote screens, watching every tick as if their lives depended on it. And unfortunately it often does! My point of view is that if you want to sit and watch every price tick you ought to just buy or lease an exchange membership and trade from the floor. I believe that day-trading should be a simple proposition, reasonably mechanical, and as objective as possible. This is the day-trader’s dream.

a. OPENING GAP HIGHER (GAP UP). This occurs when the opening price for the day is HIGHER THAN THE HIGH OF THE PREVIOUS DAY. See illustration above. By the “opening” I mean the first “print” price or the officially defined opening as determined by the given exchange. b. OPENING GAP LOWER (GAP DOWN). This occurs when the opening price for the day is LOWER THAN THE LOW OF THE PREVIOUS DAY. See the illustration above. By the “opening” I mean the first “print” price or the officially defined opening as determined by the given exchange. The opening GAP UP sets the precondition for a SHORT SALE and the opening GAP DOWN sets the precondition for a BUY.

How a Gap Buy Signal is Established
A gap buy signal occurs when a market opens on a GAP DOWN and then comes back up to penetrate the previous day’s low by at least 2 price ticks. When this occurs you BUY for a day trade. You exit your trade either at a fixed dollar amount stop loss, a stop loss below the low of the day when you are filled, or MOC (market on close).

The psychology of the sell gap is similar, only in reverse. Buyers enter en masse to cover shorts and to buy into new longs on a gap higher opening, thinking that the gap up is a sign of strength. When it fails to materialize, they exit and push prices down sharply. The psychology of the gap trade is, therefore, one of panic selling and panic buying. Gaps are highly correlated with tops and bottoms to the extent that gap trades occur frequently at or near market bottoms whereas sell gap trades occur at or near market tops.

How a Gap Sell Signal is Established
A gap sell signal occurs when a market opens on a GAP UP and then comes back down to penetrate the previous day’s high by at least 2 price ticks. When this occurs you SELL SHORT for a day trade. You exit your trade either at a fixed dollar amount stop loss, a stop loss ABOVE the high of the day when you are filled, or MOC (market on close). As you can see, the rules of application for the GAP TRADE are very simple. And the application of this methodology is simple as well.

The “Best” Gap Trades
You might think that the best gap trades (by which I mean most profitable and most reliable) occur consistent with the extant trend. This is not necessarily true. Some of the best buy gap trades occur in bear markets as short covering panics occur. Some of the best sell gap trades occur in bull markets as traders take profits en masse.

Conclusion
Gap trades have had a noteworthy history. They are reliable and often profitable because they’re based on the essential principle that underpins all tradingpsychology. As long as traders trade markets and as long as traders are human, gap trades will continue to work. And if they stop working then I’m certain other psychologically based trading patterns will take their place.

Psychology of the Gap Trade
In the psychology of the gap trade is found the reason for its excellent ability to capture winning day-trades. When a market opens on a down gap, traders often panic and sell out. If the market can absorb their selling and then move up high enough to penetrate the previous day’s low, the sellers realize that they’ve made a mistake, (OOPS, we’ve made a mistake) and enter their longs again. At the same time buyers waiting for a sign that the opening down gap was a bogus sign of weakness, enter the market and bid prices higher. The market then usually closes near its high for the day. 

 

*Excerpt from Jake Bernstein’s Weekly Commodity Trading Letter, Volume 23 #51, dated December 20, 1993 ©Copyright 1997 MBH Commodity Advisors Inc. Reprinted with permission of MBH Commodity Advisors Inc. for use by Fox Investments

THERE IS A RISK OF LOSS IN FUTURES TRADING
While obtained from sources believed to be reliable, the information contained herein is not guaranteed as to accuracy or completeness and is subject to change at any time without notice.

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