Is “Gap-Fill” Trading a Legitimate Strategy?

10/18/2010 11:43 am EST

Focus: STRATEGIES

Any subscriber to T3Live.com knows that we love to trade opening gaps in the market. Gaps often create great opportunities in volatile markets. Trading for an opening gap fill has long been a strategy among active short-term traders on any given day. Obviously, many days the gaps are relatively small, and therefore, do not offer much opportunity, but on days with larger opening gaps in the market, a prominent short-term strategy is to fade the gap. The data from 2009 confirm this concept as a legitimate strategy with a significantly “better-than-breakeven” probability of success.

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Trade Flight Plan calculated gap fills from the E-mini S&P 500 futures from 9:30 to 4:00 (not the 4:15 futures closing time). The gap fill is defined by price action that touches or breaks through the closing price of the previous trading day.

Based on Trade Flight Plan's study, trading for a gap fill every day in 2009 would have had a success rate of 66.5%. Friday's session filled the gap in 2009 far more often than Monday's, an interesting dynamic. The lower likelihood of a gap fill on Monday is probably a result of the more valid adjustment of prices from “untraded” weekend events. A greater number of events must be accounted for in the opening Monday prices, seemingly making those prices somewhat more reliable.

At T3Live.com, we often look for opening gap fills within the first hour. We teach that if the gap is left unfilled after the first hour, typically, the market will trend in the direction of the gap. This continuation strategy is the most effective when trading larger gaps (roughly greater than 1%). Based on the chart, out of the 66.5% of the days that the gap is filled, two-thirds of the time it happens in the first hour of trading.

By Brandon Rowley of T3Live.com

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