Strategies: Gap Fills

Now that we have discussed the basics of trading, this post will be another addition to the “strategies” series where we will discuss the how-tos of specific strategies. For this post, we will be discussing the gap fill strategy to be used when trading the stock market. Everyday, the regular hours trading session for the stock market opens at 9:30am EST and closes at 4:00pm EST. However, there is also the extended hours session which fewer investors have access to which generally begins trading at 6:00am EST and closes at 8:00pm EST. Very few traders are able to place trades during this time and even fewer actually do. As a result, this time is marked by incredibly low volume in the stock market as compared to the regular trading hours. Because of this, large orders can move the market significantly during this time. For the trader who only uses the regular trading hours session to look at charts, this can create “gaps” in data. A gap occurs when there is a difference between the closing price of the previous day and the opening bid of the following day. As previously stated, this is usually caused by overnight moves in the extended session which moves the market before it is to reopen the next morning. However, it can also be caused by an exceptional number of market orders set to buy or sell a security at market open. This sends a security straight up or straight down in the first hundredths of a second after the market opens at 9:30am. Because most traders do not have access to the advanced quotes necessary to accurately see this data, charting platforms will print it out as a chart gap. These gaps in data have created something called the gap fill theory. The gap fill theory says that securities prefer to move throughout the day to “fill their gaps.” Essentially, a gap fill is simply when the market will move up or down the distance of the gap in order to revert price as if the gap never happened. This creates a potential opportunity for the retail trader to profit. If off the open, a trader identifies a product that has gapped up or down, he or she may take the opposite position of the gap in hopes that the gap will fill. For instance, if a large cap stock opens with a significant gap down and no overnight news to justify a sell-off, the gap fill trader may go long that product and hope that the price will revert to the top of the gap and thus profiting from the move. The same is true for a product which has gapped up. A trader will short this product in hopes that the product will go down to the point of filling the gap and profiting from the trade. A gap fill strategy is a more specialized strategy used primarily for stock trading but you may find that adding it to your arsenal can help you profit from short term trades.

CFTC Required Rule 4.41:

Hypothetical or simulated performance results have certain limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not been executed, the results may have under-or-over compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profit or losses similar to those shown.

Hypothetical Performance Disclaimer: 

Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk of actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all which can adversely affect trading results.