Fading the Gap
Introduction
To calculate the probability success when fading the opening gap
in exchange traded index futures and develop a best trading
strategy approach.
Assumptions and definitions
What is a gap?
For the purposes of this study it is a measure from the close of
the previous trading session to the opening price of the following
trading session's Regular Trading Hours (RTH).
RTH is from 09:30 to 16:15 EST.
Instrument studied
This study was done on the S&P 500 e-mini contract traded
electronically on CME (Symbol ES).
When has a gap filled?
It is when the a trading session's closing
price has been touched during the following trading day. There is
no measure of the number of days it took to fill the gap. If the
gap did not fill that day then it is regarded as a
"no-fill" day. On "no-fill" days the
gap fade strategy closes the trade at the day's closing price at
the end of RTH (in this case 16:15 EST).
It is assumed that you can enter a short/long trade at the
opening price and if the gap fills/closes that you are filled at
the target price even if that price is only touched and not traded
beyond.
Types of Gaps
I've started to define and categorize gaps
but this process isn't finished yet. For
example, an Extreme Gap is when the opening price is outside the
previous day's high or low and an Extreme Range
Gap is when the gap is larger than the previous
day's range. There are other types of gaps or
sub types of gaps which are dependent on the day or the week/month
or size of the gap. By categorizing and boxing these gaps
I'm attempting to get a better handle on when a
gap can be faded and when it shouldn't be
faded.
Data Used
Daily OHLC RTH ES data from 15 January 2002 to 20 February 2004
(529 trading days with 528 gap observations).
The results of the study
The results of the study will be presented as a series of
answers to questions. Charts will be presented as often as
possible. The profits and losses are shown in ES points unless
otherwise stated.
Limitations of study
Because the data set only has OHLC figures for the ES it is
impossible to tell if the gap closed (if it did indeed close)
before the most adverse movement (draw down) happened for any one
day. For this reason the worst is assumed and if I use a stop loss
in any of the studies it is assumed that the stop loss is hit
before the gap is closed if the draw down is within the range of
the stop loss.