Fading the opening gap

Discussion in 'Strategy Development' started by guy2, Jun 2, 2004.

  1. guy2


    If anybody uses the gap fade as one of their trading strategies then you may be interested in a study that I recently did using 2 years of ES daily data to determine the validity and profitability of fading the opening gap in this instrument:


  2. Guy,

    Interesting but ... I would point you in another direction. Instead of looking at the gap between ES from RTH to RTH, you might look at the ES at open vs. where the S&P500 index closed the day before.

    I trade NQ and DAX gaps and find the difference is night and day. Particularly for NQ, a Cisco or Intel can gap the market after 4:00pm EST and that gap wouldn't necessarily appear as a gap in your study ... or did I miss something? I've found these type of gaps to be among the most lucrative and it doesn't seem they would be captured by your study.
  3. guy2


    Have you looked at this before? What sort of results did you see?

    I don't fully understand your reference to a Cisco or Intel gap? You're correct in saying that a Cisco or Intel gap won't appear in the study because this study strictly limits itself to ES RTH. What I'm trying to gain in this type of study is:
    > A practical approach to actually using the strategy on the ES.
    > Tables of probabilities to assist in trading the gaps.
    > Benchmarks to measure your performance against.

    The Daily Notes page (http://www.deltat1.com/DailyNotes/DailyNotes.htm) has a summary of the gap fade at the bottom to provide a benchmark to measure your performance against the "raw" gap play for yesterday and the month to date.

  4. I haven't done a systematic study of how I trade gaps, but it has been a low risk, consistent reward strategy for me.

    I like your general approach exept that I believe comparing RTH ES/NQ close-to-open gaps is largely a waste of time for two reasons. First, these markets are only closed for, what, one hour? That is hardly time for any meaninful gap to materialize. Thus 90% of the gaps you are looking at are mere noise and slippage/execution becomes quite problematic. Put another way, NQ might open on the trade of only 1-2 contracts before closing the 'gap' - where does that leave your strategy?? Second, the risk/reward is quite ugly, as you highlighted yourself with the discussion on drawdowns.

    For my purposes, an opening 'Gap' in NQ is the difference between NQ and where the NQ100 index closed at the end of the previous trading session. Thus, if the index closes at 1500 and Cisco earnings at 5:00pm move the NQ to 1512, I'm looking at a ~12pt gap, at that point in time, ahead of the open for next trading day. If you redo your study along these lines I would bet $$ you can get better results, but if this is to be automated you will need to use stops such that you are taking low risk / high reward positions.
  5. ...you must be a genius trader and applying a little english to your trades, because I have exhaustedly backtested NQ overnight gaps and there ain't no system there, at any gap threshold.
  6. The problem might be that you are trying to build a 'system.' I don't use systems, and I don't trade most 'gaps' that a system would pick up. By definition anything that can be systematized will be exploited until it is gone anyway, and is a waste of my time.

    Judgement, on the otherhand, is priceless.

    Did I say 'judgement'? I meant to say 'genius' :)
  7. dbphoenix


    I wouldn't say it takes genius, just a lot of work.

    The primary determinant of whether a gap is going to go this way or that is where it takes place in reference to the previous day and where within the trading range all this is taking place. If the trading range has been exited, then there are a different set of criteria to apply.
  8. Gaps work on individual stocks (so you can be on the same "side" as the Specialist, ride his coat tails). Futures trade all the time, and don't really have gaps. There are no real gaps on the OTC market. Check with TASC, they did a decade long back test on simple gap with NYSE stocks (proof of concept, even though they had not tweaked it at all).

  9. dbphoenix


    Technically, you're correct. However, futures traders do not trade futures "all the time". Therefore, their behavior is influenced by an opening price which is substantially different from the previous day's closing price.
  10. guy2


    I think that there is some confusion as to the parameters used in the study. ES RTH is from 09:30 to 16:15 EST. Even thought the ES trades electronically overnight from 16:30 to 09:30 the following morning, this trading and price movement is ignored and the gap is calculated as the difference between the official settlement price (set between 16:15 and 16:30) and the opening price the following trading session at 09:30. All times are EST.

    This is explained in the intro to the study which is the first link on the page:
    #10     Jun 2, 2004