OVERNIGHT GAP SELECTION Part 2: Trading Article by Daryl Guppy

Continued from Part 1...

Alternatively we use the JustData snapshot service. We take the first available snapshot of market data at 11.30. This downloads all open, high, low and close prices to that point in time. From this data we can assess the difference between the high of yesterday and the open of today. We then run the Metastock gap exploration scan shown at the bottom of these notes. The filtered list is printed and the charts created with GTE. Speed is not important, but nor do we want to take too long to make this initial assessment. Of the 53 stocks in this example, only 8 meet our conditions.

The next filter is volume on the previous day in particularly, and over the previous week in general. We are planning to trade crowd enthusiasm, so we expect to see some evidence of this on the day prior to the gap. The appropriate volume depends on our trading objectives. If we want to trade $5,000 position size then we accept a lower volume than if we want to trade a $20,000 position. We need some evidence that there is sufficient volume to support our planned trading size.



If this is supported by trading volumes during the week then it is an added advantage – a double tick. This is not a critical factor. Many of the best gap trades happen when volume floods the market. The previous week, or weeks of trading activity may be very low. The stampede changes that. This is why volume on the day prior to the gap open is more important than volume in the previous week.

In the next column I include the bar pattern. An excited crowd will close prices near the high on the day prior to the day. This is the most bullish pattern. A close above the open is the next most bullish. A close equal with the open is acceptable, but it must be supported by other bullish factors, including a very strong Guppy MMA relationship. A close lower than the open is the least effective chart pattern. This a crowd that lost enthusiasm and this makes it unsuitable for our strategy based on continued enthusiasms.

The final note in this first selection process is the trend pattern. This combines both Guppy MMA analysis and recent trend direction. The best pattern is a straight edge trend line pointing upwards. The next most bullish is a rising trend that has shown a small retracement. The current gap open signals a resumption of the up trend. This may be extended to include a retracement followed by a sideways move and then a rebound from the consolidation pattern.

The least attractive opportunity is created by a breakout from a downtrend. Instead of a gap trade, this becomes a breakout trade using gap strategies. The danger in this type of trade is that the rally may collapse when it hits a resistance level. There is a higher probability of a rally being overwhelmed by sellers. There is less probability if this is a trade that takes place in an established up trend. The desperate need to sell to cut losses or lock in small profits on the first breakout has usually disappeared.



We want crowd enthusiasm and trend strength.

The eight candidates are reduced to six, although we have included PCE in this example. Normally we would eliminate PCE because it is a rally breakout in a strong trend. It has a low probability of success.

We are left with three final filters. We shift from the chart to the live depth of market order lines. The first uses the current order line to determine the volume of trading activity. The best relationship has three characteristics.

a) More buyers than sellers.

b) good trading volume on the buying side. We want to be able to place our order.

c) A reasonable spread between the bid and the ask. If it is too wide we either have to wait for prices to pull back, or pay more than we should to get hold of stock.

PEM and BRY meet all these conditions. The spread with PCE is too large. The buyer wants to pay $0.24 but the nearest seller is asking for $0.345. This spread eats away at the potential profits in this strategy, so we ignore it.

ABK has very low trading volume. Our order would dominate the market. SSI has more buyers than sellers, but the order line has low volume.

We are looking at this screen up to forty minutes after the open of trade. Our strategy is based on continued crowd enthusiasm so this should show up in two ways. The first is a continued increase in prices, or at least, not a slip back to the level of the previous day’s high. Secondly, there should be lots of activity in the stock. We want a large enthusiastic crowd fighting amongst themselves to get hold of stock.

This is the penultimate filter. Those candidates with active trading go to the top of the list. RBT which met the order line conditions, fails this activity test. Forty minutes after the open, only a few trades have been completed. There is no crowd here.

The final filter is price. Our preference is to select the opportunity with the best price leverage. A $0.10 stock is preferred to a $0.50 stock, or a $1.00 stock, all other factors being equal. Lower prices mean there is more opportunity for a substantial price rise today, and tomorrow. It increases the percentage return from the trade.

From this list we select PEM because we believe it has a stronger chart pattern than BRY.

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Article contributed by Private Trader, Market Expert, Trading Coach and Best-Selling Author Mr. Daryl Guppy. For more articles and commentaries from Daryl Guppy, click HERE.