Trading the Open of the U.S. Equities Market
By Melissa Armo, TheStockSwoosh.com
A random walk. That is what most people think the stock market is. Just a series of random events with no predictable pattern or link. Just total randomness.
Well, the fact is that most people are right. Most of the time during the trading day the market is random and has no predictable pattern.
This is why so many lose. I have traded the market for years, but realized long ago that MOST of the time the market is random, and people try to make too much out of insignificant patterns that give little odds of success. However, success comes from those few times where there is NOT randomness, when there IS a predictable pattern. When you find these times, it is when you have an edge.
To me, there are two primary times when you have this – two times when you have an edge, when equities give reliable patterns. One of those times comes from what we call ‘shock value’. Shock value can happen first thing in the morning in the U.S. equities market.
Because the stock market closes at 4:00pm EST and opens at 9:30am EST, there is a period where trades cannot take place. Yet events still occur. News still happens, stocks are still upgraded and downgraded, companies are still sued, and companies release earnings. As a matter of fact, companies intentionally release earnings when the market is closed. 99% of earnings are released during non-market hours. Any one of these events can cause tremendous demand to buy or sell a stock, yet it cannot be done. The market is closed.
Yes, there is post- and pre-market trading. But even if you include that, there is still a long period of time when there is no trading. And the post- and pre-market trading is not always reliable. It is generally light volume, and some participants are not able or willing to participate. Either way, the tremendous pent-up demand causes a void in the price chart. This means at open, traders and investors can be instantly rewarded, or punished. This creates four groups of traders/investors. There are those that have to buy, those that have to sell, those that want to buy, and those that want to sell.
This can lead to big swings in these equities at or near the open. Let’s be clear about something. We’re not talking about predicting the actual gap. In all my years, I have to tell you, it is not possible to predict the actual gap. That is nothing more than gambling. No research, no indicators, nothing but actual inside information can help you predict the gap. We are talking about how to play the stock once it gaps, regardless of whether you knew it was going gap. Here are a couple of examples.
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In this example, GRPN gapped down (right arrow) and after the gap down, it moved another 20% over two days. Notice that, over two months ago, the stock gapped up and moved over 30% in one day; again, that is not counting the gap itself. Note also that if you owned the stock over four months, you would be only break even at best. If you played the stock the day of the gap up or the gap down for just the day, you played a stock that moved more in one day than most stocks do in an entire year.
This works in both directions. While ‘fear’ can drive prices lower at a faster rate, the proper bullish gaps can have the same effect.
YELP moved over 13% on the day it gapped. That is, from the time it opened, the entire move is able to be captured beginning at market open after the gap occurred. Notice something else. More than half of that move, over 7.5%, occurred in 20 minutes.
This should be amazing to you if you’re not aware of it already.
This is not a rare event. There are usually multiple stocks per day that this happens to. Because earnings announcements create an event that can cause additional gaps, this occurrence is usually more frequent during the time known as “earnings season,” which happens for about four weeks every three months.
Remember, big funds always have rules, and they often require that the fund cannot hold a position that goes a certain amount against them. This means big money is often forced to exit whether they want to or not. This often causes a snowball effect as the decline in price causes so much pain for other traders, that they sell, which creates more of a drop, which causes more pain and other traders to sell, etc. Take a look at the power of the recent STX daily chart.
Power. The power of big money. And if you know what you are doing, it can be one of the most predictable moves. These charts you are seeing are all the subject matter of plays that were discussed or traded on the morning that these gaps occurred in the Stock Swoosh Live Trading Room. This stock had two separate gaps that both created huge moves in a relatively short period of time. It is very common for a lot of that movement to happen first thing in the morning. Take a look at the 15-minute chart on the day of the second gap of STX.
That one single 15-minute bar moved over $3.00, or almost 13%. That was the bulk of the move for the day. By looking at the long- and short-term patterns prior to the gap, you can often get clues, usually very accurate clues, as to how the stock will react at open.
The stock called FEYE had a different type of gap. You can see the gap here on the daily chart, and yes, it produced another big red bar.
Now notice the five-minute chart. It started off green. Buyers.
This was very predictable if you look at the daily chart. Yes, there were ‘buyers,’ but that doesn’t mean they were bullish. Who buys a stock and is not bullish? Simple. It’s traders who had short positions and had to ‘buy’ to exit the position. Looking at the chart, it was clear there were many with short positions. Couple that with a ‘big’ gap, and you get profit takers. Add to that those mistakenly thinking that this is a buying opportunity, and you get a morning bounce. But buying soon runs out. And those that bought because they were bullish are soon proved wrong and they add fuel to the fire by having to exit and add more pressure to the selling. Look at the pure powerful selling going into 10:30.
And finally one more example. Here is the daily chart of FIT.
Again, knowledge of the gap and understanding the daily chart is key. This stock was a little ‘all over the place’ during the first hour, but there were two great entries.
However, knowing and understanding what is happening this is very playable. The early play was possible, because when buyer are proven wrong on the opening bar, there will be selling. It came quick. But often the stock grinds back in the morning, but then sells off for the rest of the day. That 10:30 high marked the high for the rest of the day, and very strategic entries were available — entries that are high odds with great risk to reward.
Putting all of this together, trading morning gaps is not hard, but it is very counter intuitive for many new, or even somewhat experienced traders. Very simply stated, trading the proper, quality morning gaps is one of the few times you truly have an edge. If you are sick of hit or miss concepts, ask yourself what ‘edge’ do you currently have in your current trading strategies. Trading professional gaps has you trading on the side of big money. This means big moves. This means fast moves. This means that once you know the entries, stop outs are fewer than with most trading strategies.
Thank you for reading this article. If you are serious about trading then feel free to reach out to us. I teach and trade only one method on gaps which I alone created. My method sets up fast and the trades move with momentum quickly, so you can trade and get on with your day. I only trade the first half hour of the market day. It is easy to follow my trades as I call them live while I'm taking them and only trade one stock at a time, and usually one stock only per day. There is no chitter-chatter in the room, it is just trading and teaching. If you want to make money and are focused on doing so then The Stock Swoosh can help teach you how. At the Stock Swoosh we have one focus during one time frame in order capitalize on trading the first 30 minutes of each day with a focus on shorting stocks that meet certain criteria.
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