There are a number of common theories and misconceptions about opening gaps and how to trade them. Trader Jack himself has always maintained that it is wise to 'mind
gap', and strongly recommends not dashing madly after a market powering away unless you REALLY know what you are doing. We therefore felt it might be useful to investigate common gap trading ideas and comment on them for our readers at www.traders101.com .Here are results of a study on Nasdaq, including every gap in last 15 years. At first glance, Trader Jack rule 'never chase gap' looks like a good rule - over 70% of gaps get filled on day they occur, i.e. the market falls back to previous day's close before end of session. Also worth noting - average size of a gap on Naz (both long and short) is just over 1.16%. As you might expect, small gaps get filled more often than big gaps - there is 'less work to do' for market to reverse a small gap.
Larger gaps have a tendency to stay open more than small gaps - for example, a gap that is twice as large as average gap (2.33%) will typically remain open over 60% during session (although they may get closed again next day). Likewise, a gap 3 times size of an average gap will remain open almost 65% of time on day. At top of scale, gaps that are 3.5% larger than an average gap remain unfilled almost 90% of time on day they occur. They may only get filled 21% of time during week, too!
This data tends to suggest that a reasonable gap trading strategy might involve trading against (or 'fading') small and average sized gaps, and to 'go with' a large gap. So how does one implement such a system? Let's take a closer look.
