Trading Techniques  |  NOV 1999

Trading The Opening Gap by Stephane Reverre

Trading The Opening Gap by Stephane Reverre Is it possible to profitably trade a gap opening from the previous close? Here’s one trader’s test of that idea using Dow Jones Industrial Average (DJIA) stocks as the subjects. Profitably buying an opening dip or selling an opening pop, depending on the size of the move, is possible, but it’s not easy money. I systematically tested taking a position in the morning following a gap at the open and unwinding the position at the close of the same day, regardless of profitability. What I found was that the strategy, though not hugely profitable, was consistently profitable. Here’s an example of how you could do the analysis yourself, complete with code (see Traders’ Tips). CONVENTIONAL WISDOM If nothing is happening, there is no reason why a stock’s price would jump one way or the other. Therefore, mild price movements are the general expectation. What I wanted to capture were abnormal movements -- above a certain trigger level -- because, in those cases, I expected a correction. I could not predict the speed of the correction, but still, I reasoned, if unwarranted gaps were spotted quickly, it should take at most a few days for investors to realize that a particular stock had been unduly inflated or hammered. Because I restricted myself to a single trading day, I estimated -- or at least hoped -- that this correction would be initiated quickly and completed at the end of a single session.

by Stephane Reverre