![]() I first screen the daily universe of 8,000 listed stocks using the following criteria: I use Zipline with QuantRocket's 1-minute US stock data to backtest a buy-on-gap strategy. The strategy typically targets stocks in an uptrend, expecting that traders will buy the dip. ![]() The selling pressure immediately exhausts itself, however, leading the stock to recover through the remainder of the session. The reasoning behind the strategy is that bad news causes traders to enter sell orders overnight which execute in tandem at the open, causing a temporary liquidity shock which drives down the opening price. Buy the gap?īuying stocks that gap down is a common trading strategy. This post uses Zipline to explore down gaps and finds a profitable strategy based on selling, not buying, the gap. If they have no follow-through, you might have a reversal trading setup.What happens when strong stocks gap down at the open? A well-known trading strategy is to buy the gap, expecting mean reversion. Look out for bars with abnormally wide range bars with high volume. High volume is a sign of trend exhaustion even without gaps. (Like the triangle formation in the winning example.) However, you will miss some of the best reversals that take off without looking back. These entries will offer a tighter stop-loss. If you are uncomfortable with large stops, wait for bullish chart formations or bar patterns before entering. (Reverse for bearish reversal.) Placing a tighter stop will expose us to whipsaws which are common after price fills the gap. However, in the exhaustion gap trading strategy, the safe stop-loss level is the extreme low of the trend for bullish reversal. Hence, it is a great basis for trading a reversal. The exhaustion gap is distinctive because it gaps further with higher volume. There are four types of gaps including common, breakaway, runaway, and exhaustion. In this case, we might have mistaken a common gap for an exhaustive gap. While this trade failed technically, it is somewhat exhaustive as it halted the down trend. Instead of reversing the trend, price fell and made a new low, stopping out all reversal traders.For exhaustion gaps, the sooner it is filled, the more likely we have a reversal. ZION filled the gap on the fifth day, which makes it less impressive than the BCR trade which filled it on the third day. This down gap looked like an exhaustive gap with extreme volume.Every reversal trade needs a trend to reverse.It shows a gap that was not exactly exhaustive. This is the daily chart of Zions Bancorporation (ZION). However, BCR did not make a new lower low after the gap, which confirmed that the gap was exhaustive. While this exhaustion gap caught the market low, the timing was not great as price meandered sideways after our entry. Using the triangle measuring rule gave us a good first target. Price closed the gap within 3 days and we bought as soon as price closed the gap. The bullish bar that followed the gap showed strong bullish pressure. This down gap made a new low with extreme volume. ![]() But generally, the longer the trend, the more likely a reversal trade will succeed. You can define the market trend using your own trading methods. The orange line is the upper line of a Bollinger Band (233,3) for finding extreme volumes. An up gap with extreme volume (as we defined above)Įxhaustion Gap Trading Strategy Examples Winning Trade - Bullish Reversal.A down gap with extreme volume (as we defined above).Any volume bar that exceeds the upper Bollinger Band is extreme. In this case, we want to find extreme volumes, so I applied a 233-period Bollinger Band with 3 standard deviations using the volume bars. I have a standard method for finding extremes using Bollinger Bands. (Read: 4 Types of Trading Strategies) Rules For Exhaustion Gap Trading StrategyĪn exhaustion gap occurs with extremely high volume. Hence, the exhaustion gap trading strategy is a trend reversal play. ![]() Having no more fools to buy after them, the trend is ready for reversal. ![]() The gap represents a surge of ultra-late buyers. In a bull trend, an exhaustion gap is an up gap that represents the last climatic buying. If the gap is an exhaustion gap, then the answer is probably yes.Īn exhaustion gap is found after a trend is exhausted. Is it time to grab your profits and go? Is it time to reverse your bias and sell short the stock? Imagine waking up to find that your favorite stock has gapped up overnight and given you a windfall profit. Review - Exhaustion Gap Trading Strategy.Exhaustion Gap Trading Strategy Examples.Rules For Exhaustion Gap Trading Strategy. ![]()
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