Trading The Opening Gap by Stephane Reverre
Is it possible to profitably trade a gap opening from the previous close? Hereís one traderís test of that idea using Dow Jones Industrial Average (DJIA) stocks as the subjects.
Profitably buying an opening dip or selling an opening
pop, depending on the size of the move, is possible,
but itís not easy money. I systematically tested taking a position in the morning following a gap at the open and unwinding the position at the close of the same day, regardless of profitability. What I found was that the strategy, though not hugely profitable, was consistently profitable.
Hereís an example of how you could do the analysis yourself, complete with code (see Tradersí Tips).
If nothing is happening, there is no reason why a stockís price would jump one way or the other. Therefore, mild price movements are the general expectation. What I wanted to capture were abnormal movements -- above a certain trigger level -- because, in those cases, I expected a correction. I could not predict the speed of the correction, but still, I reasoned, if unwarranted gaps were spotted quickly, it should take at most a few days for investors to realize that a particular stock had been unduly inflated or hammered. Because I restricted myself to a single trading day, I estimated -- or at least hoped -- that this correction would be initiated quickly and completed at the end of a single session.