Each is effective in its own right. These are relatively short-term indicators; however; their implementation can also lead to longer-term opportunities.
While some of these patterns may seem familiar to you, please note that I do not necessarily implement them the way most traders do. So please note well the differences and above all observe that these methods all use the setup, trigger, and follow-through method discussed in previous lessons. I also want to reiterate that the STF structure is the most important procedure that you can follow in all stock and futures trading (as well as most other forms of speculation and investing).
This lesson is considerably more detailed than what you have seen in the lessons so far. You need to read it over a few times to get it straight. Note that, although these are primarily day trades, they do not require you to watch the markets all day long. If you do not have an interest in day trading then you can skip this chapter. Nevertheless, I think that the concept of the gap will be helpful to you because gap days tend to mark important turning points above and beyond the day that they occur.
Pattern 1: the gap trade
The gap trade (GT) is one of the simplest short-term methods in existence. Paradoxically, it is also one of the most misunderstood methods.
Use day-session daily-price data only. If a market opens below the low of the previous day, the market has set up a gap buy trade. If a market opens above the high of the previous day, the market has set up a gap sell trade. After a gap trade buy setup (GTB), a trigger occurs when and if the market goes back up through the low of the previous day by a certain number of ticks. After a gap trade sell setup (GTS), a trigger occurs when and if the market goes back down through the high of the previous day by a certain number of ticks.
There are three follow-through methods as follows: Exit on stop-loss (to be discussed). Exit on close of day win or lose if not stopped out. Exit on first profitable opening (FPO). These three follow-through methods will be discussed later in this lesson.
The importance of gap days
Gap days are very important because they often have the following common characteristics: Many major tops and bottoms occur on gap days.The trading range on gap days tends to be large. Gap days often occur as a result of news. Gap days provide very reliable day trading and short-term trading opportunities.
Gap days tend to be highly emotional. The close on a gap day tends to be near the extreme of the day. The opening on a gap day tends to be near the extreme of the day. Trading volume tends to be large on gap days.
If a market opens on a gap above the high of the previous day by more than a certain amount ( the penetration amount), then place an order to go short a given amount below the high of the last day (see below for amount).