howitradegaps-030213

Copyright 2013, MasterTheGap.com

How I Use Historical Probabilities to Trade the Opening Gap

Scott Andrews


Disclaimer

This material is intended for educational purposes only and is believed to be accurate, but its accuracy is not guaranteed. Trading and investing has large potential rewards and large potential risks. You must be aware of, and fully

understand, these risks and be willing to accept them in order to invest in equity, futures, options, currencies and other financial markets. Do not trade with money that you cannot afford to lose. This material is neither a solicitation nor an offer to

buy or sell equities, futures, options, or currencies. No representation is being made that any account will or is likely to achieve profits or losses similar to those

discussed. The past performance of any trading system or methodology is not necessarily indicative of future results..

Use this information at your own risk!!


Agenda

Ø  The Basics Ø  How I Trade Gaps Ø  Selection Criteria

Ø  Execution

Ø  How To Get More Free Research


Gap Basics


GAP

What Does a Gap Look Like?


Close

•  Next day gaps down •  Opens at $47.61 •  Fills the gap precisely

$48.38

Example of Gap: Daily Chart


Example of Gap: 5 Min Chart

Next day opening price (9:30 am ET)

Prior day closing price (4:00 pm ET)

Price retraces & fills gap


The Easiest Trade of The Day

1.  Gaps have an inherent bias and edge (70% win rate).

2.  Can prepare in minutes before open.

3.  Can trade them without charts from anywhere.

4.  Minimal slippage due to opening volume.

5.  “Fire & forget” – place order and walk away.

6.  Entry & target are pre-defined, no need to manage

7.  Risks are limited and controlled - no overnight risk.

8.  They work in bull and bear markets equally well – no need to predict the

market’s next move.


Definitions u  Fade: to trade in the opposite direction of the gap u  Gap Fill: when price retraces from the open to the

prior day's close (4:15 pm ET) u  Win %: percent of opening gaps that, if faded at the open,

fill the gap or end the day profitable

u  Profit ratio = gross profits from winning trades Factor: gross losses from losing trades

u  ES: E-mini S&P futures u  ATR: Average True Range (the average range of each

session, inclusive of opening gaps)


The Promise of Gap Fading Year Number of Gaps Win %* 2012 227 69% 2011 243 67% 2010 228 71% 2009 236 69% 2008 235 68% 2007 223 64% 2006 203 73% 2005 194 72%

2004 205 71% 2003 204 76% 2002 228 74% Total: 2,426 70.4%

* January 1 - April 30, 2008

*Win %” is based upon hypothetically fading opening gaps > 1 point in the E-Mini S&P 500 futures, 2002-2012, targeting prior close, exiting end of day if gap did not fill. This not a recommended strategy.


The Paradox Year Profit Factor* 2012 1.10 2011 1.01 2010 1.20 2009 1.21 2008 0.88 2007 0.72 2006 1.04 2005 1.13 2004 1.17 2003 1.38 2002 1.21

Average: 1.10 (yawn) •  January 1 - April 30, 2008

Profit factor = total profits of winners / total losses from losers Though an extremely high win rate, the profits from

the winners barely exceed the losses from the losers.

*Based upon hypothetically fading opening gaps > 1 point in the E-Mini S&P 500 futures, 2002-2012, targeting prior close, exiting end of day if gap did not fill. This not a recommended strategy.


Using Stops Does NOT Improve Profitability

Stop As % of Gap Size % Win Average Win/Loss Ratio Profit Factor

25% 20% 4.1 1.04

50% 35% 2.0 1.07

75% 45% 1.3 1.03

100% 51% 1.0 1.05

125% 57% .80 1.05

150% 60% .70 1.05

175% 62% .65 1.05

200% 64% .60 1.05

Note: 1998 – 2007, E-Mini S&P 500 futures. Regardless of stop size,

fading all gaps remains a breakeven strategy.

*Based upon hypothetically fading opening gaps > 1 point in the E-Mini S&P 500 futures, 2002-2012, targeting prior close using a stop = % of gap size. This not a recommended strategy.


The Key to Profitability:

SELECTION


How I Trade Gaps


Select Trades Like John Venn

Trade only when the majority of historical criteria are supportive

Copyright 2012, Master The Gap, Inc.


How I Select Gaps to Fade

Zone

Pattern

Market Condition

Seasonality $

I analyze each gap based on it’s opening zone and how it has performed historically under similar scenarios


“Gap Zones”

Definition: location of the gap relative to the prior day’s key price levels: Open, High, Low and Close.

High Close Open Low

“Location, location, location”… applies to gaps too!


Why Gap Zones Work

They inherently incorporate: •  Support and resistance •  Short term trend •  Gap size •  Trader psychology

High Close Open Low


Direction of Prior Day Should Be Considered Too

Open Close

Close Open

Prior day “direction” incorporates the short term trend.


Gap Fade Win % By Gap Zone Win % Prior Day 55% 62% 73% 81% 66% “Win %” is based upon hypothetically fading ~2,500 opening gaps > 1 point in the E-Mini S&P 500 futures, 2002-2012,

targeting prior close, exiting end of day if gap did not fill. This not a recommended strategy.

Prior Day Win % 65%

84%

75%

70%

53%


Tip: Avoid Gaps That Open Below the Low of an Up Day

BLUD Gaps!

Prior Day

AVOID!


Entry Timing


Why I Enter At The Open

Ø  Simplifies execution

Ø  Minimizes emotion

Ø  Takes advantage of “rookie” psychology (i.e. those chasing the market)

Ø  Easier to back-test

Ø  Focuses the effort on the system (not me)

Ø  Catches all of the winners...


Stop Placement


The Stop Dilemma

Using small stops does not improve profitability due to the reduction in win rate.

Stop As % of Gap Size % Win

25% 20% 4.1 1.04

50% 35% 2.0 1.07

75% 45% 1.3 1.03

100% 51% 1.0 1.05

125% 57% .80 1.05

150% 60% .70 1.05

175% 62% .65 1.05

200% 64% .60 1.05 *Based upon hypothetically fading opening gaps > 1 point in the E-Mini S&P 500 futures, 2002-2012, targeting prior close using a stop = % of gap size. This not a recommended strategy.

Average Win/Loss Ratio Profit Factor


Stops

•  25% – 40% of a five day ATR (avg. true range) works well for most market / equities depending upon the volatility of the security

•  50 – 80 cents in the SPY or 5 – 8 points in the E-mini S&P 500 has worked well historically

•  If I increase stop size to accommodate volatility, then I always reduce position size to ensure my max loss per trade is not exceeded

•  I never hold losing trades overnight

Stop size is more of a personal preference than profitability determinant


Results of My Called* Gap Trades: 2011-2012

•  113 wins •  56 losses, 3 scratch •  ~ 67% win rate •  ~ 1.28 profit factor (ratio of profits to losses from all trades)

* Each was posted at “Today’s Gap Plays” page on the website for members prior to the opening bell and prior to my entry.

Individual results vary. There is no guarantee that I or my methodology will enjoy similar success in the future.


Summary •  Historical probabilities level the playing field between the

“Pros” and the “Joes”

•  Gap selection is THE key

•  Know the zone!

•  Entering at the open has many benefits

•  Use a stop size that fits you & your desired win rate

Thank You


www.masterthegap.com/tradingpub

… for a copy of the slides

and a BONUS video: “8 Gap Facts Every Trader

Needs to Know”

Go to:


If you would like to learn more about:

Gap Trading

using

Historical Probabilities…

Join me at MasterTheGap.com

or consider…


“Master Gap Trading” Premium DVD Series

Ø  “The Opening Gap” DVD set ü Two hours on 2 studio recorded DVDs & 1 CD

Ø  “Profit from the Opening Gap” DVD set ü Three hours on 3 studio recorded DVDs & 1 CD

Ø  Regular price: $495, available through March 15th:

$97 total ( use coupon code: pay97 ) Ø  30 day money-back guarantee if not fully satisfied

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