Morning Gap Trading Strategy: Profitable Tips for Trading the Market Open

What are Stock Gaps?

So, what is morning gap trading? A price gap is defined as the difference between the prices of a security's opening price and closing price. Gaps can occur for various reasons, but news announcements or earnings releases most often cause them. There are a variety of types of gaps to trade, but they can be broken down into two main categories:

• Breakaway gaps or Runaway gaps (Gap and Go): when stocks gap and run at the market open
• Exhaustion gaps (Gap and Fill): when stocks gap and fade at the market open

These setups are integral to every gap trading system as they can traders with high probable opportunities. When trading the opening price gap, paying attention to both the price action and the volume is important. Volume is what tells us whether or not the gap is significant.

Gap trading techniques are so popular because of the percentage of gaps in the stock market that eventually get filled. Unfortunately, this number is extremely high, which presents a high probability trading opportunity to scalpers and swing traders.

In the example below, we can see the price chart has a bunch of "stock gaps" between the candles. This shows what gaps can look like on a stock chart.

Morning Gap Trading Strategy

Now that we know what morning gap trading is let's discuss how to utilize it. There are two main ways to attack gap trading in the morning: breakouts and reversals. Bullish breakouts occur when the opening price of security gaps up and then moves higher. Bearish breakdowns occur when the opening price of security gaps down and then continues to move lower.

Reversals occur when a stock gap down and then starts to move back up or gaps up and starts to move back down. Reversal gap trading is a bit trickier, as you're essentially betting against the stock gap. Therefore, it's important to understand the key factors that cause this before entering into a reversal trade—all of these key factors later in the article.

How to Scan for Gapping Stocks?

Every gap trading system needs to have a quick and easy way to scan for these setups. Luckily, many traders can scan for stocks gapping up every day, which allows them to prepare before the market even opens. This is extremely crucial because entering trades with no plan is a recipe for failure. Scanning for these setups is simple and easy using many trading platforms on the internet. The one we are going to use in this example is tradingview.com. This website allows traders to scan for stocks based on hundreds of criteria. One of them is the premarket gap %; the traders can set this number to their desire based on how large a gap is needed to trade. Typically the smaller the gaps, the higher chance that they get filled the same day, while larger gaps can take multiple days to play out.

As you can see in my scanner below, I have also added two more filters to give me more quality plays. I have added stocks above 10 and volume above 50k, which is important. Volume can be key to knowing before the market even opens if the gap will hold. If the premarket volume is high, this can lead to quick continuation in the first 5 minutes. If the premarket volume is low, this can lead to a quick reversal in the first 5 minutes.

What is a gap fill?

A gap-fill (exhaustion gaps) is a reversal gap trading strategy. This is when the opening price of a security gap increases and then starts to move back to the previous day's highest price. The example below shows that the stock produces a gap and later fills the gap by moving lower to the previous day's high. Gaps in the market have a high likelihood of getting filled, making this a golden trading opportunity. With this example below, recognizing the right factors that lead to the gap fill can help the traders prepare before the move happens. Again, we will discuss this later in the article.

For a bullish gap-fill, this is where the stock will gap down and run higher to the previous day's low. Both scenarios talked about are seen as weaknesses in the stock. Understanding how to trade them is the key.

What is a gap and go?

A gap and go (breakaway gap) is a breakout gap trading strategy. This is when the opening price gaps up and then continues to move higher or gaps down and continue to move lower. A breakaway gap can be seen in the example below as the stock forms the gap in the morning and continues to sell off for the first 30 minutes. A breakaway gap is a great chance for traders to recognize and be a part of a profitable momentum move. Momentum in the stock market usually produces some of the best trades, and that is why traders will focus on only trading morning gaps. These breakaway gaps give the highest chance opportunities for daily momentum plays.

Many factors contribute to knowing if the stock will likely continue that we will discuss next.

Key Factor for Gap Trading Strategies

Now we know the common gaps used in most gap trading strategies, let's discuss what can cause a gap in the stock to reverse or continue in the initial direction. The only downside is that playing these types of moves happen in the first 30 minutes, which can be really risky to traders and lead them to lose money quickly. But, on the other hand, being on the wrong side of the move can be really easy if these factors are not analyzed correctly. That is why it is so important traders develop gap trading rules to avoid these situations. So let's run through them.

Volume

The key to any movement in the stock market is volume. Lack of volume typically means weakness. This could mean weakness in a current trend and a high chance of a reversal. Weakness for a gap up or down means the stock is likely to fill the gap. On the other hand, if a strong volume is present for the stock in the morning, there is a higher chance of the stock continuing.

In the example below, you can see that the stock gapped up but did not have the volume to sustain this continuation. One easy way to tell if a stock has high or low volume is to add a simple moving average. A 30 moving average was added to the volume in the chart below, which means anything above the line is considered high volume, and anything below the line is considered low volume.

One possible reason the stock gap reversed was that the volume for the first 40 minutes was underneath the average. This would put the stock in a bad place if sellers were to profit (which they end up doing). The lack of volume not only leads to a gap reversal but turns into an all-day sell-off. Once momentum enters a stock, it typically has a hard time leaving.

Indicator Readings

The next key to finding gap-fill scenarios is adding an oscillator to your chart. Indicators or oscillators allow traders to know overbought or oversold conditions. These readings on indicators typically give traders high probable places for consolidation or reversals.

When a stock gaps into these readings, it is considered an exhaustion gap. If we pair this with gaps and low volume, we can sometimes find home run setups that allow traders to play these gaps. The only reason an indicator will stay in these overbought or oversold conditions is with volume. With no volume, we can see really easy reversing setups.

The best indicators for seeing overbought conditions could be the Market Mover (try for free for 10 days), RSI, or stochastic.

In the example below, we will overlay the Market Mover on the price chart to show when the stock produces overbought conditions. As you can see, the stock opens higher with an exhaustion gap and puts the indicator in an overbought condition. This can also be seen by the Market Mover turning red. While the price trend doesn't reverse instantly, it ends up consolidating and then finally filling the price gap later in the day (touching the previous days high).

Candle Sizes

Next, we will discuss how candle sizes in the first 30 minutes can determine the likelihood of the stock continuing or reversing. When the market opens, the first 5 candles will be crucial. Typically, large candles starting to fill a gap are a sign that buyers are not interested in buying at these price levels. If no buyers are interested, the sellers will quickly drive the price lower and lower through the gap with large candles. The larger the candle, the lower the chance buyers will defend this gap and continue the trend.

In the example below, we can see an aggressive gap in a stock that produces huge reversal candles. This is a clear opportunity for gap fill, and the larger the gap, the larger potential profits. The Market Mover indicator is also bright red which tells us that the stock already had a slim chance of continuation. The key to finding support and possibly saving this trend is finding smaller candles with wicks on the bottom. Unfortunately, this stock continues to have large reversal candles, leading to further downside. We don't find tighter, smaller candles until later in the day when the stock finally bottoms.

While the gap fill strategy is an opportunity to play the stock down, a trader also can trade the bottom after confirmation, and finding these tight candles with wicks can be that confirmation.

Next, let's talk about the power of small candles forming in the first 30 minutes. Small candles, in general, mean there is a battle between the buyers and sellers. For the stock to gap up with tight candles, this tells us buyers are interested in these elevated prices and absorbing the selling pressure. After fully exhausting the sellers, this is when the stock has a chance to continue higher and higher. Again, the smaller the candle, the higher the buyers are defending this gap and want to continue the trend.

In the example below, we can see an aggressive gap in a stock that is not being reversed as easily. This is a clear opportunity for a gap and go. The stock gives traders plenty of places to enter the trend with tight inside Doji candles. In a good trend, the stock will have the large candles continuing higher and produce those tight ones on a pullback. At the same time, this is the opposite for a gap and fill, where large candles are on the downtrends, and the tight candles are on the pops higher.

Price Action

Lastly, analyzing price action is the best way to fill these gaps. The rules for price action are really simple and help us know the trend at the very moment:

• Bullish Trend: Stock continues to make a higher and high and a higher low which can lead to continuation
• Bearish Trend: Stock continues to make a lower and low and a lower high with can lead to continuation
• Weak Bullish Trend: Stock makes an equally high or a lower high, which can lead to a reversal
• Weak Bearish Trend: Stock makes an equal low or a higher low which can lead to a reversal

In the example below, we can see that the price pattern makes higher highs and higher lows than the previous. This confirms the bull trend and allows traders have a higher indication of a gap and breakout scenario. Just seeing the first higher high and higher low reading in the first 30 minutes would have given the trader enough confirmation to enter with confidence in a gap and breakout.

In the example below, we can see the stock makes lower highs and lower lows compared to the previous. This confirms the bear trend and allows traders to have a higher indication of a gap and fill scenario. Just seeing the first lower high and lower low reading in the first 30 minutes would have given the trader enough confirmation to enter with confidence in a gap and fill.

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