What Is Opening Price Gap?
The opening price gap is common phenomena in stock or commodity markets across the world. As this market closes and opens at a particular time, frequently overnight changes occur which affects the equation of supply and demand. This change in supply and demand is reflected in the opening price. When the price opens above or below the last day closing price it is called a gap. Many times these opening price gaps are easy money in stock market trading for vigilant and skilled traders.
Common Gaps And Technical Gaps
Not all gaps in price are of similar importance. If opening price is within the range (price area between high and low) of the previous day then it is called a common gap. If opening price is outside the range of previous day it is called technical gap. As the price has opened completely outside the previous day range, it represents an important overnight change. The technical type of gap can provide us an opportunity of earning easy money in stock market trading.
Trading Price is more or less under the control of operators of the particular stock. These operators are aware of the large buy or sell orders waiting for execution. So these operators always want to keep the price in their favor.
Any unexpected overnight change due to some economic, company specific or general market event can destroy the plans of their operators. So they try to catch up with the fresh supply or demand by opening the price in the gap.
Life would be too easy if opening gap always represented true intentions of its operator, but sometimes it can be exactly opposite
The opening price can be quite confusing and you can be trapped at top or bottom. Sometimes the price opens above PH and then price just go down and down this is called intraday bull trap. Sometimes the price opens below PL and then price just go up and up this is called intraday bear trap.
How To Use Gaps In Intraday Trading?
Gaps As Stock Selection Tool
The technical gap in opening price can be very useful as a stock selection in intraday trading. Whenever any stock opens with the technical gap, most of the time it results in good price momentum in the direction of the gap. Price momentum is a must for profitable intraday trading. Only trade stocks which have opened in a technical gap.
You can download afl code for an automatic stock scanner in Amibroker in the download page in the menu after registration. To know more about stock scanner for technical gap please watch the video at the end of the post.
Protect Your Capital With Proper Stop Loss
Now after filtering stocks with the technical gap still we are in the risk of intraday bull trap or bear trap. So we must apply proper stop loss depending upon the condition.
We have the following three option of proper stop loss.
Suppose you are trading a bull technical gap. If you have bought above open and open is the lowest price then your nearest stop loss would be the open price.
If the price has gone lower than open. But still the L>PH then your nearest stop loss would be low price(L).
The last option of your stop loss is previous high (PH).
Execute your stop loss as soon as the price enters the territory of previous day range. Do not wait beyond PH because now there are more chances of being bull trapped. Apply opposite logic if you are trading bear technical gap or gap down.
The above are technical guidelines for proper stop loss. One should align it with his trading plan. Stop loss also depends on position size, risk reward ratio and trading style other than technical.
When To Book Profit
When one trades a stock with a technical gap in the direction of the gap, the chances of success are quite greater. So if everything is going well, there comes the question of when to book profit. If the stock is in momentum then you can use any trend following system for exit such as MACD, Moving Average, Magic Trend Indicator, ADX etc. But the most preferable is Magic Trend Indicator with its default settings in 5-min chart. The following 5-min intraday chart is explaining the trading plan with magic trend indicator.