During the night, economic news and events affect the markets even after they have closed for the day. As a result, traders often wake up to see gaps in price movements the next morning. The markets open each morning with a level of chaos in reaction to news releases. While this might place extreme pressure on long-term traders, many successful day traders suggest this time as a prime opportunity in their personal trading tips.
It has become increasingly easier to trade outside of standard market hours. However, market makers – those who deal in securities – still maintain a level of control throughout the day. Market makers will either buy or sell a stock in the direction of a trend and manipulate the market by offering these shares themselves. The higher the selling price of a stock, the better for the market maker. By increasing the demand as the price increases, they can profit from those who place market orders for that stock. Usually working on behalf of a larger trading institution, market makers are able to skew the trends to their advantage. Although this is often difficult to avoid, you can make smarter trades and profit from the resulting gaps in the market.
There are many types of gaps that can be analyzed, but this article’s focus will be on the two main classifications: full and partial. A full gap occurs when the opening price is either above the previous day’s high or below the previous day’s low. The gap is full because the previous day’s last candle does not overlap with the current day’s first candle. This type of gap is usually preferable, but it does indicate higher volatility.
A partial gap occurs when there is a gap between the closing and opening price, but they do overlap at a point.
The first thing to understand is that a gap automatically indicates a high and low point on the chart. In a bearish gap, the top of the previous candlestick will mark the high, while the bottom of the current will mark the low.
The first of these trading strategies is to open trade 30 minutes after the market opens. You should take a long position if the price has moved higher than the previous high or a short position if the price has gone below the previous low. This is considered to be a relatively risky strategy.
A less risky entry approach is to wait for 60 minutes after the gap’s position to monitor the direction of the trend. After 60 minutes, you will assess the price movement and open your positions in the corresponding direction.
It is always recommended that you put some form of money management steps in place to protect yourself from risks. Before opening your positions after the gap, decide the amount of risk you are willing to take for that trade. A good standard setup would be to have tighter stop loss orders for the 60-minute strategy and looser stops for the 30-minute strategy. This is because volatility is highest during the first 30 minutes but begins to decrease after this, eliminating the potential for a profitable trade. With this in mind, the exact percentage at which you should place your stop loss orders must be determined in relation to your stock’s volatility.
Beyond these simple steps, taking profits from this method requires a variety of management strategies. For example, moving averages and profit targets play a large role in your gap trading decisions. One option is using a trailing stop to exit from a profitable trade. A trailing stop loss order can be placed slightly after the trade meets your set profit target. This method is simple enough to master and reliable enough to produce profits when used correctly.