One of the toughest trades to make is off an opening gap. Opening lower gaps require some patience to see if or when a bottom is achieved (Nov 16 a great example), while a gap up is a tough mental challenge – do you jump on board and go long as the train is quickly gathering steam, or do you fade it? Momentum in markets these days is the great equalizer, get on the wrong side and pay the price. I’ve had my share of good and bad results. Often when on the right side I will use the strength or weakness to unload positions. I will rarely open new swing trades (but may do some intraday trading) as these extreme moves are unlikely to follow-through. If perhaps there is some continuation, then there should be some safe entry points.
Gaps Will Play Games with Your Mind
There is more ‘shock and awe’ with a gap than a smooth open that trends all day long. Why is that? Gaps tend to be faded because the moves are excessive, fierce and extreme. Your mind tends to get twisted as you contemplate whether to fade the move or go with the flow. This decision is where big money is constantly won or lost, really not much edge unless the conditions are perfect for your style. Go ‘too far, too fast’ and at certain levels the selling (or buying) will commence.
On Nov. 19, the S&P 500 (SPX) gapped higher and nearly made their highs in the first 40 minutes of trading, leveled off and stayed high the entire session.
Gap Trading Advice
My advice would be to avoid playing the gaps unless you are willing to play it light, be nimble and just accept smaller gains. There’s nothing wrong with being just a ‘little right’.
