gaos mess up my trading plan - what to do

chibiks

Member
52 0
gaps mess up my trading plan - what to do

I have a fairly good trading system... I trade on weekly charts. But one problem I have still not found a lasting solution to is gaps! There is no way to know its coming, suddenly, and you have a huge loss. Are gaps created to eliminate weak hands in the market? Or create fear? There is no logical reason for its existence. Most people will say gaps exist because the 'floor' opens the market to match buy and sell orders; this is still vague at best. Gaps strike me as some manipulation by insiders to achieve a desired market benefit - any ideas on gaps real cause (not vague) and what can be done to minimuze its effects?
 
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member275544

0 0
Re: gaps mess up my trading plan - what to do

I have a fairly good trading system... I trade on weekly charts. But one problem I have still not found a lasting solution to is gaps! There is no way to know its coming, suddenly, and you have a huge loss. Are gaps created to eliminate weak hands in the market? Or create fear? There is no logical reason for its existence. Most people will say gaps exist because the 'floor' opens the market to match buy and sell orders; this is still vague at best. Gaps strike me as some manipulation by insiders to achieve a desired market benefit - any ideas on gaps real cause (not vague) and what can be done to minimuze its effects?

Why would you think gaps are a result of manipulation...just because your market may have closed for the day, many many equities are listed on multiple exchanges.
Take Lloyds for example. There is LLOY.LON there is LYG listed on the new york stock exchange. Take a look at the charts, they are identical, only the prices are different. Why? because they were listed with a different capitalisation on that exchange. So when you go to bed, thinking the UK market is closed, lloyds is still being traded. Look at the opening price of Lloyds now on the NYSE, that will gap up because it had a great trading day in the UK
No manipulation, nothing trying to catch all those traders out..just different market participants in different timezones.
Out of interest lloyds is listed on just those two, there are others listed on more
 

barjon

Legendary member
10,605 1,745
If you're trading shares you can take out some insurance with a pro-rata overnight hedge on the underlying index. Won't protect you from share specific news, though.
 

timsk

Legendary member
7,349 2,143
Hi chibiks,
In addition to the point made by malaguti, you need to keep in mind that the individual stock you're trading does not exist in a vacuum. By that I mean the factors that influence its share price extend well beyond the company itself, its staff and balance sheet etc. A good company in a weak sector will be pulled down by the other companies in that sector. A strong sector in an overall weak market will be pulled down by the other sectors and companies in the index. The index itself, say the FTSE 100 or the S&P 500 will be influenced by general economic news and world events. And, even when the cash markets are closed, the futures markets continue to trade. When the cash markets open the next day - or after the weekend - they have to rebalance with the futures markets which could have moved a long way from the previous day's close or the close last Friday before the weekend. For more info' on the relationship between cash and futures, check out this Essentials Sticky: Essentials of Indices.

The individual company you trade - even if it's a massive blue chip - is but a cork bobbing about on the ocean waves in the great scheme of things. If there's a report in the Sunday papers that the chief financial officer has disappeared with $100 million from the company's accounts and was last seen in some tropical paradise with no extradition agreement - you can expect the share price to open lower on Monday morning! Or, imagine you're trading a company in the oil and gas sector and the news breaks over the weekend that there's been another disaster like the Horizon oil spill in the Gulf of Mexico a few years ago. Even though it has nothing to do with the company you're trading, nevertheless, chances are it will affect its share price. As a crude rule of thumb, only 30% of the factors that influence the share price of the company you're trading are to do with the company itself. The remaining 70% are to do with external factors such as those I've mentioned.

As to what to do about it - there's no easy, simple answer that I know of. However, I don't swing or position trade equities - so I'm not really the person to ask. Nonetheless, here are a few things to consider:
1. If you're long XYZ oil stock, you could open an ETF short of the oil and gas sector as a hedge to protect you from a possible gap down over the weekend.
2. Alternatively, you could find another highly correlated stock to the one you're holding and open an opposing trade in that. Come Monday morning, if the price of your 'main' stock has fallen (assuming you're long) - then you'll be covered by the gain on the short.
3. Whilst overnight and weekend gaps are common, they typically fall into a historical range. So, once you know what that range is for the instrument you're trading, you can factor it in as part of your risk and money management plan. You'll do that by adjusting your position size and setting a sufficiently wide stop loss to accommodate a gap against you. Add in an extra 20% or so to give yourself some margin for error. That way, most gaps will be within your tolerance levels. You'll get caught out once in a while for sure. Equally, luck will be on your side and there will be the occasional huge gap in your favour. Beware of earnings season though - as 'normal' stats can easily get blown out of the water!
4. If you have a spread betting account, you could protect yourself with a guaranteed stop loss.

Hopefully, other members who face this problem will chip in with their suggestions.
HTH.
Tim.
 

CityMasterTrader

Member
77 2
I have a fairly good trading system... I trade on weekly charts. But one problem I have still not found a lasting solution to is gaps! There is no way to know its coming, suddenly, and you have a huge loss. Are gaps created to eliminate weak hands in the market? Or create fear? There is no logical reason for its existence. Most people will say gaps exist because the 'floor' opens the market to match buy and sell orders; this is still vague at best. Gaps strike me as some manipulation by insiders to achieve a desired market benefit - any ideas on gaps real cause (not vague) and what can be done to minimuze its effects?

The existence of gaps is purely a feature of correctly functioning markets. If there are no buyers to buy from the sellers when the market opens (for example), no trades can take place. So, if you’re keen to sell your asset at 100p, but the best any buyer is willing to pay is 90p, the best you can get is 90p. When the last trade was at 100p, but the next buyer is at 90p, you’ve got a market gap.

For every buyer, there must be a seller.

Have a look at an equity trading platform with level 2 data – you’ll see the whole market, which consists of buyers and sellers. It should clarify things for you.

I think gaps could be used to your advantage (I’ve often considered this, but never had the time to put together a solid strategy). I’m thinking along the lines of guaranteed stop-losses on assets that you expect to be volatile. So, if you see that historically a stock gaps 20% on average after results. It’s a choppy one. You could go long with a guaranteed stop (as tight as you can), and on the same asset go short (as tight as you can). Therefore, as long as it gaps either way, you’ll be stopped out on one and profit on the other. Just make sure your risk/reward is correct.

Option traders call them straddles/strangles I believe (my knowledge of this is limited).

Anyway, is there a strategy to be had there? Keep me posted!
 
 
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