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How do we manage opening “gaps” in the market?

January 24, 2012

MTG Opening Gap Rules

Due to large changes in overnight supply or demand, both the major market indices, and individual stocks and ETFs, will often open much higher or lower than where they closed the previous day, which is known as a “gap.” Buying or selling short a stock that hits its trigger price due to a large opening gap can be riskier than entering a stock that trades through its trigger price in an orderly fashion. Likewise, open positions frequently gap to open beyond their stop prices, but immediately reverse back in the right direction. Therefore, MTG has instituted the following rules to manage positions that gap well beyond their trigger or stop prices. This article explains how MTG treats opening gaps, but is not to be construed as advice or a recommendation of a specific strategy.

  • Stocks and ETFs that gap open beyond their trigger (entry) prices:If a stock or ETF opens at least 1% beyond its trigger price (above the buy trigger for long setups or below the sell trigger for short setups), we temporarily put the trade entry on hold. However, we will continue to monitor subsequent price action of the stock or ETF throughout the day. If we observe an ideal entry price, such as a pullback, we will promptly send an Intraday Trade Alert (via e-mail and/or mobile phone) informing of adjusted entry details. If no entry alert is received, subscribers should assume we did not enter the trade.

    NOTE: This entry rule only applies for stocks and ETFs that gap open 1% or more beyond our trigger price. If the opening gap is less than 1%, the trade is automatically entered 10 cents above the 5-minute opening high (for longs) or 5-minute opening low (for short sales).

  • Stocks and ETFs that gap open beyond their stop (exit) prices:All protective stops that trigger within the first five minutes of trading are ignored. If a stock or ETF trades through its stop price within the first five minutes of trading, a new, firm stop is automatically placed 10 cents below the low of the first five minutes. After the first five minutes of trading, if a stock or ETF is trading at least 1% beyond our original stop price, we automatically adjust the stop to be 10 cents below the low of the first 20 minutes of trading. In the event of a “shakeout,” this gives the position a chance to reverse. However, in situations of extreme weakness, we may not wait for a break of the 20-minute low (changes would be made via Intraday Trade Alert).

The above rules summarize how we typically manage gaps, and are designed to keep you out of trouble by preventing you from entering or closing a trade at the worst price of the day. However, just like every other rule in trading, there are always exceptions to these rules that will enable experienced traders to occasionally deviate from these rules with high success rates. These are nuances that cannot be taught, but can only be learned through experience. MTG follows these rules every day, unless subscribers are informed otherwise. These rules are designed to avert major losses, which is much more important than whether you leave some profit on the table or not.

Let’s look at a few examples of the MTG Opening Gap Rules in action, just to make sure you’re clear.

Example 1: The pre-market setup, as per The Wagner Daily, is to buy the Semiconductor HOLDR (SMH) if it trades above a trigger price of $35.55 today. But due to positive news that occurred overnight, the broad market gaps up, and SMH opens at $36.37, which is 2.3% above the original trigger price of $35.55. Because the gap was greater than 1% beyond the trigger price, we avoid buying SMH on the open, then monitor the price action for a lower risk entry. If one is found, an alert with trade details is sent to subscribers. Otherwise, we pass on getting into the trade. Following the MTG Opening Gap Rules in this scenario will prevent you, time and time again, from buying at the high of the day, only to watch your position immediately reverse.

Example 2: The pre-market setup, as per The Wagner Daily, is to buy the iShares DJ Transportation Average (IYT) if it trades above a trigger price of $91.00. IYT opens at $91.42. If IYT is still trading above $91 after the first five minutes of trading, we then buy 10 cents above the opening 5-minute high. No special action would be taken because the gap is less than 1%. Small gaps that hold up after the first few minutes of trading are likely to keep moving in the direction of the opening gap. But if IYT opened above the $91.00 trigger price, but was trading below that price after the first five minutes of trading, we would wait for IYT to subsequently move back above the opening 5-minute high before buying.

Example 3: Going into the open, we have a protective stop price of $81.30 on our long position of Ultra QQQ ProShares (QLD). Gapping down slightly, QLD opens at $81.22. Since we ignore any stop that triggers in the first five minutes of trading, we now wait until the first five minutes of trading has passed, then set a new, firm stop just 10 cents below the five-minute low. If the opening gap down in QLD would have been at least 1% below the stop price of $81.30, we would wait for the first twenty minutes of trading, then set a stop 10 cents below the 20-minute low.

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