“The Cowboy” Gap Fade

SFO WebinarMay 18, 2010

Scott Andrews

Disclaimer This material is intended for educational purposes only and is believed to be accurate, but its accuracy is not guaranteed. Trading and investing has large potential rewards and large potential risks. You must be aware of, and fully understand, these risks and be willing to accept them in order to invest in equity, futures, options, currencies and other financial markets. Do not trade with money that you cannot afford to lose. This material is neither a solicitation nor an offer to buy or sell equities, futures, options, or currencies. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed. The past performance of any trading system or methodology is not necessarily indicative of future results.

Use this information at your own risk!!

Agenda

• The Basics

• How I Trade Gaps

• Gap Zones

• The Cowboy Gap Fade Setup

• For More Info ...

What is a Gap?

The most common definition is the difference between

a security's opening price and its prior session/day closing price.

This difference shows up visually on a price chart as an open space or “gap.”

Example of Gap: 5-min. Chart

Next day opening price(9:30 a.m. ET)

Price retraces& fills gap

Prior day closing price(4:15 p.m. ET)

1. Gaps have an inherent bias and edge (>70% win rate).

2. Can prepare in minutes before opening bell.

3. Can trade them without charts from anywhere.

4. Minimal slippage due to opening volume.

5. “Fire & forget” – place the order and walk away.

6. Entry & target are pre-defined – no need to manage.

7. Risks are limited and controlled – no overnight risk.

8. They work in bull and bear markets equally well – no need to predict the

market’s next move.

Indices (S&P, Dow, Russell, Nasdaq) are ideal gap trading markets due to liquidity, reversion bias & ease.

The Easiest Trade of the Day

How I Trade Gaps

1. Focus on SELECTION (Avoid the clouds!)

2. Enter at the open

3. Hold for gap fill or beyond (rarely scale out prior to fill)

4. Use a LARGE enough stop to let probabilities work (Fly close, but not too close to the trees!)

How I Select Gaps To Trade

“Gap Zones”

Definition: Location of the opening pricegap relative to the prior day’s key price levels: Open, High, Low & Close

High

Close

Open

Low

“Location, location, location” … applies to gaps too!

Fill Rates By Gap ZoneWin % Prior Day

60%

62%

77%

77%

66%Note: Fading opening gaps > 1 point in the E-mini S&P 500 futures, 1998-2009, targeting prior close, exiting end of day if gap did not fill.

Prior Day Win %

68%

81%

75%

67%

55%

The Cowboy Gap Fade Setup

• Following a “down” day that closes below the low of 2 days prior

• Next day gaps up and opens BELOW the low of 2 days prior

• Enter short: at open or wait for reversal signal (often near the low of 2 days prior)

• Target: gap fill area or beyond (i.e. near prior day lows)

The low of 2 days ago often serves as resistance and sellers will often appear in this area

The Cowboy Gap Fade Setup

Win %

73% (gaps opens above)

79% (gap opens below)

Low of 2 days prior

Prior Day

“The Cowboy”

Cowboy Gap Fade Stats (S&P 500)• About 15-25 times per year (250 in past 12 years)

• 79% fill rate (using end of day stop) & profit factor: 1.35

Target gap fill:

• Using stop = 20% of 5 day ATR: 60% & 1.5 PF

• Using stop = 30% of 5 day ATR: 69% & 1.5 PF

• Using stop = 40% of 5 day ATR: 75% & 1.5 PF

Stop size is more of a personal preference than profitability determinant

Example of The Cowboy Gap Fade

Example of The Cowboy Gap Fade

Example of The Cowboy Gap Fade

Example of The Cowboy Gap Fade

Trading Tips

• If the market is just starting to sell off, then holding some of your position for a test of the prior day’s lows or beyond (or until end of the day) is often very profitable

• If the market has been selling off for several days or the prior day is a wide range day (>1.5*5 day ATR), then targeting gap fill area works best

• The setup works best Wednesday – Friday

Be sure to study this strategy with the equity or instrument you are trading before risking capital

Summary

• The Cowboy Gap Fade is a high probability technique

• You may need to ride it like a “bucking bronco” due to the volatile nature of the opening price action for this setup

• Stop size will have a big impact on your win rate

• Targeting beyond gap fill can significantly improve your total profits

Ride ’em Cowboy!

For More Info

Email: sfoslides@masterthegap.com to: • Receive these slides and option to download prior SFO slides• Option to sign up for “Daily Gap Wrap” email• Learn about my other upcoming webinars

Buy the book: Understanding Gaps (Available at: www.traderspress.com)