OVERNIGHT GAP TRADE MANAGEMENT by DARYL GUPPY

The gap trade may be executed using ordinary stock, or using a derivative, such as a CFD. The derivative increases the return from the strategy. It also increases the risk in the strategy particularly if the CFD is based on bid-line triggers rather than traded price.

Management of the gap trade covers two days. Broadly they can be described as the entry day and then the exit day. The analysis for this strategy does not start until 20 minutes after the open of the market. By the time the analysis is completed the market may have been trading for an hour. This means that prices may have moved well above their open. If we are particularly lucky, price may have experienced a retreat as often happens after an initial market rally.

The important point is to remember that the success of this strategy rests on entering the stock on day 1 with the objective of exiting the trade on day 2. Rather than attempt to buy the bid it is more effective to hit the ask. The order screen shows a bid at $0.57 and the ask at $0.58. Getting a position is more important than haggling about the entry price. We take the entry at $0.58.

In this trade we miss the low of the day set at $0.56. We miss it because we are still involved in analyzing the potential trading candidates. This is significant if our focus is on trading the extremes of price action. It is less important in this strategy as our objective is to capture a portion of the price movement. We continue to stress this because so many traders feel cheated if they miss the price extremes. This attitudes blinds them to many other successful trading strategies.

Success depends upon running a tight stop loss. Using the low of the day we set a stop loss 1 tick below this level. A tick is the minimum price move permitted in the stock. With PEM, prices move up or down by one cent at a time. There are no half cent bids. Our stop loss is set at $0.55. This is an automatic stop loss. This has several advantages. The first is that the stop is executed automatically so you do not need to sit in front of the live screen all day. This automatic execution overcomes the temptation not to act. It is an artificial boost to discipline.



The second advantage is the speed of execution. Traders who use mental stop loss points have to watch the screen all day. Once the alert is sounded as a trade takes place at the stop loss price they must contact their broker. This means ringing, or logging onto the net, bringing up the screen, locating the stock, creating the order, and then clicking the sell button. The time from the stop loss alert to order execution may be a minute or more. In that time it is possible that prices may have slipped several ticks below the planned exit point, creating an unexpected large loss.
There are several critical features of this strategy. Rapid stop loss execution is one of them which is why I use an automatic electronic stop loss order.

It takes time for news to travel through the market. PEM has gapped upwards on the open, but it drifts sideways for an extended period. In the afternoon a new flood of buyers come into the market. They temporarily lift prices to $0.62. Some traders start to take profits at this level, and their selling drops prices back to a close at $0.60. Our objective is to remain in the trade, so we do not chase this rise as a selling opportunity. However, the rise provides the opportunity to lift the stop loss and shift the trade into a breakeven opportunity.

The initial, or morning, stop loss is placed one tick below the low for the period. The afternoon stop loss is placed after prices start to pull back from the high. The objective is to protect our capital. Lifting the stop loss means that the worst outcome is a break even trade – unless prices gap down past the stop on the next day’s trading. However, with a gap open today and a higher close on increased volume this is an unlikely outcome.

In a position trade – a trade designed to be open for days or weeks – it is sufficient to set a stop loss at the end of each trading day. On an intra day, or short term trade, there are significant advantages in shifting a stop loss several times during the day. The first shift should provide total protection for capital. Later shifts should start to lock in profits, and this is the first step on the second day of the trade. Stop loss points are only lifted upwards. They are never lowered.

Will continue in the next article...

> Related Article: OVERNIGHT GAP SELECTION Part 1 and Part 2

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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.