Last Updated on June 11, 2021 by Oddmund Groette
What is an opening gap?
A gap is when the opening price (or print) is higher or lower than the previous close. A gap up indicates the opening is higher than the previous close and vice versa.
Other traders might define gaps more stringent: a gap up is when the opening is higher than yesterday’s high, and a gap down when the opening is lower than yesterday’s low.
Types of gaps
There are many types of gaps, however, the three most common are runaway gaps (breakaway gaps), exhaustion gaps, and common gaps.
As the name implies, these are gaps that are “common” and frequent. For example, the S&P 500 opens up or down more or less every day. Most of the days this is just noise and hardly worth to write about (in the news). Typically, the gaps are in the range of plus/minus 0.25%.
This gap is often called breakaway gaps. This gap usually leads to higher or lower prices in the same direction of the gap. If it gaps up, we can expect higher prices in the future.
However, it’s easy to explain with hindsight.
Exhaustion gaps happen after an already extended move in one direction.
For example, if the S&P has had a sudden move over several days upwards, we have a potential exhaustion gap if it one day gaps up more than normal (average).
An exhaustion gap signals the end of the move: it’s the climax.
Do gaps get filled?
It depends on the size of the gap and time. Most small gaps are filled the very same day, while bigger gaps need more time (days) to get filled. You can read more about gaps in this article.
Some gaps need many many days to fill, some even months, and some never (applies more to single stocks – not indices).
Can you predict a gap opening?
The activity in the market before the official opening is easy to spot. All liquid ETFs and futures contracts indicate where it’s gonna open, of course, it might vary from minute to minute.
You can also use statistics to indicate the probability of a gap up or down opening the next day based on statistics.
Opening gap strategy in the S&P 500
Today I did my personal twist on this strategy. Over the last two months, I’ve been trading a similar strategy, but not exactly the same as the one I’ve tested here.
Here are the details (for long):
- If SPY gaps down lower than -0.15% but higher than -0.6%, go long at the opening print/cross. The reason I use -0.6% as the maximum is that SPY shows a lot less mean reversion if opening lower. To me that makes sense. Usually, there is not that much “news” if SPY opens for example -0.4% down compared to for example 1%. However, if SPY opens more than 1% down it’s a good short, vice versa for long if it opens above 1%.
- Target is 0.75 of the gap. If it opens down -0.5%, the target is 0.375% higher than the fill price. If the target is not reached exit is at the close. No other stops.
- Yesterday’s close must be lower than 0.25 of this formula: (close-low)/(high-low). The reason I use this is because of SPY’s mean-reversion tendencies. It means fewer fills, but a higher average per fill. The tighter I set these criteria, the better average per fill (but obviously less fills).
The test period is from 1. January 2010 until August 2012. In total there are 110 fills and 98 winners. The average per fill is a respectable 0.19%. Here is the equity curve:
Here is the distribution:
Small winners and occasionally a big loser.
The data is adjusted for dividends and collected from Yahoo! and IQFeed. I have tested on both data sets with not much difference. I have used EOD quotes, ie. only open, high, low and close.
I wrote this article on the 20th of September 2012. A perfect day for this strategy. SPY opened down about 0.47% and filled the gap all the way up until yesterday’s close.
The strategy seems very robust and yields very good numbers. Perhaps too good to be true? Yes, it’s probably too good to be true. The reason is that some of the high and low quotes are wrong which boosts the numbers. That’s why I’ll write a second article on this strategy and test it on intraday data from IQFeed. Then we’ll find out if there is a discrepancy in the data sets (which I believe it is).
Any thoughts about this strategy? I know this strategy didn’t perform very well some years ago. However, markets always change and we have to adjust. You won’t find a strategy that lasts year after year.