Protection against gaps

Discussion in 'Risk Management' started by Aetey, Apr 21, 2010.

  1. Aetey


    I've been a lurker around here for some time now and I think it's about time I stepped forward and said hello.

    So there, hello board. :p

    I'm in the process of designing my first EOD trading system: so far it's results aren't exactly stellar (approx. 5% annualized profit for 2005-2009, 2010 remains to be tested) but it's got a positive expectancy so far - so I'm kinda happy.

    But I've got a problem here (and I'm sorry if it sounds kinda noobish but hey, I'm a noob :p) - how do you guys manage gaps? My MM rules do not allow a risk exposure that is greater than 2% of my total account equity on each trade and I enforce those rules with a stop.

    But WHAT THE HECK can I do against sudden, and immediate, price changes? Like a stock gapping up (or down) on the open, taking much more out of my position than what I initially intended and against which I wanted to protect myself in the first place?

    Is there an easy way to protect against this scenario? I mean easy, not talking about hedging or pair trading here, something * I * could grasp?

    Or do I just have to take the hit and move on?

    How do you guys set up your stop loss orders? Market price I suppose?

    Gapping doesn't happen very often with the stocks I trade (as a matter of fact it happened once over the 5 years of historical data I backtested against) but still, it's kind of a scary thought...

    So there you go. Any input would be greatly appreciated,

  2. spindr0


    In order to minimize the loss from a stock gapping against you you're going to need something that makes money when that happens. A pair might help unless it's stock specific news. In that case, only a protective option will suffice. But since you stated that you're not interested in pairs trading or hedging, the answer is NOPE, there's nothing you can do.
  3. If it has happened only once in five years and was not a catastrophic event stop worrying about it.
  4. nothing you can do. An example:

    I bought CSIQ recently and was trading a gap down. By this I mean I bought CSIQ long and entered on 21.25, with plans of exiting at 22 to close the gap. Had a stop loss set at the previous days low. All was looking good, the gap was closing, and tehn the market closed. I was trading this well ahead of any earnings call. However, mgmt of CSIQ decided it was a good time to release some press talking about a 20 million dollar hit they are going to have to account for in Q1. After market immediately went to 19 a share and blew past my stop loss, i sold out first thing this morning. I have been trading gaps like this for a while and this is the first time this has happened. I am chalking up to a fluke b/c of the news release. Oh well, move on to the next trade.

    I agree with others, if you have only had 1 stock gap and hurt you over 5 years, then just chalk it up to a fluke and move on
  5. lindq


    There isn't anything you can do. If you are going to hold positions overnight, then you are exposed to either market or company risk.

    If your daily schedule permits, look more closely at developing systems that can have you flat at EOD. You can take on more size, have greater risk control, and sleep at night.

    Good luck.
  6. protective options never hurt. But don't hold them longterm, as they time decay (get them at least a couple months out, as the last month the time decay accelerates.

    You can also play around with buying/writing/covered calls/etc. Do a little homework first.
  7. I think there are banks out there that now offer equity gap options. Unfortunately, all OTC.