Friday, September 16, 2005

Strategy Session: Get Gap Trades Like This

Our friends at, The World's Largest Site for Traders, publish a weekly stock picking lesson in an article called, "The Market Next Week." The valuable advice is provided by Brice Wightman who is their editor-in-chief. Below is an example of how Brice's strategy is modeled in Trade-Ideas.

This example demonstrates how our subscribers can test the advice from quality sites like TradingMarkets or, conversely test the snakeoil from Charlatans on the merit of their ideas.

First the article and then the strategy follow:

Keep Your Eyes And Ears Open And Get Trades Like This...
By Brice Wightman

Keep Your Eyes And Ears Open And Get Trades Like This

CNBC runs down all the top news stories of the day before the open, everything from mergers, earnings, FDA approvals--you name it. Friday morning before the open, Joe Kernan mentioned that Southwest Airlines (LUV) was added to Merrill Lynch's "Focus 1" list, and that 16,000 brokers would be telling their clients to buy the stock. (Certainly brings back the old days for me---that's what I used to do, and for none other than Merrill Lynch). Picture this: within minutes, everyone and his brother is either calling their broker or placing orders online to buy this stock. So, at the open, guess what happens to the stock? It gaps up, which is really no big surprise. The way to play these, in my opinion, is to wait for the pullback and then jump on board when the stock rallies from the pullback. Here's how it looked (Ed.: 5 minute chart for Friday, March 18, 2005):

No surprise on the gap up. The stock pulls back and then flattens out before starting its rally from the pullback. I am showing you this not because the dollar move was large, but because you can find trades like this almost every just have to keep your eyes and ears open. So look for these starting on Monday--but don't be the guy placing the order before the open and getting the top tick!

The Strategy as Modeled in Trade-Ideas

The pattern described by Brice above is called a "false gap retracement". This is where the stocks attempts to fill the gap but then changes direction and continues past the gap price from the opening. In addition you can tell Trade-Ideas to look for all the stocks that cross below the opening price as the pullback begins.

Here is the strategy modeled in Trade-Ideas. There are several conditions that will generate alerts: 1. When the stock crosses below the open price 2. When the stock pullsback 25% from the retracement 3. When the stock retraces to its Fibonacci 68% amount and 4. When the stock crosses above the open price after finishing its pullback pattern. Both conditions are subject to a filter which only considers stocks that have gapped up from the open by $0.20 or more. Note that the alerts for these conditions are mutually exclusive - the only filter they are all subject to is the requirement that they gap up at least $0.20 or more. Make sure to click on "Configure" to see the actual settings or "History" to see the backtest of this strategy across several days.

Gaps Up and Waiting for Pullback to Enter


Carlo Giuntoni said...

As a daytrader of the german DAX future I am awre f this for quite a lng time. A gap retracement exist not only at the bull side but also at the bear side.
It is often seen that such a retracement extends to the last high or last low of the preceeding day

D TradeIdeas said...

Very true carlo. The example can be reversed for the bear scenario. Try doing it yourself by configuring the opposite in the 'Configure' link when you open the window. Good luck.