In trading, gaps happen almost every day. Gaps indicate that something has changed overnight. The bigger the gap, the more significant it is. Some gaps allow us to have an educated guess on the direction of the day. In today’s blog, let’s look at what kind of information we can find from gaps.
Below is a table breaking down the gaps in SPY from -4% to 4% in 0.5% increment. The data is from January 2000 to February 2022. Notice that we have the number of occurrences, the average & median % change from the Open to Close, the total % change, and the % of times where we closed higher.
There are a few key takeaways from this table. First of all, nearly 72% of gaps are between -0.5% to 0.5%. Although if a gap is 0%, it’s not actually a gap but let’s just put it in this category for simplification. Furthermore, gaps that are more than 2% have a very small sample size, so no real conclusions can be draw from them.
When we gap down from -0.5% to -2%, we tend to continue going lower. The data shows that the average % change from the Open to Close for this kind of gaps is from -0.08% to -0.15%. Furthermore, the % of times where we closed lower is from 50% to 52.7%. Consider that the stock market has the tendency to go up overtime, this is a good information to keep in mind, but it’s probably not an edge by itself.
The real edge is when we gap up from 0.5% to 2%, we have a strong tendency to continue higher at a high frequency. The data shows that the average % change from Open to Close for this kind of gaps is from 0.04% to 0.81%. The median % change from Open to Close are 0.13% to 0.72%. In addition, we closed higher than the Open more than 58% of the times!! That’s pretty significant.
Below is the equity curve for a strategy of buying SPY every time it gaps up 0.5% – 2% and exit at the end of the day.
Notice that prior to 2010, this strategy didn’t perform very well. However, since 2010, this strategy has performed nicely in this bull market, and the equity curve is very smooth. This probably means that this tendency doesn’t really exist prior to 2010.
Here are the stats for buying gaps between 0.5% to 2% on SPY from 2010 forward. You can see that the average % gain and median % gain as well as the win rate increased significantly over this period.
On a final note, can this strategy be trade by itself? Maybe. However, that is not how I would use it. For me, it’s a good tendency to understand and use for day trading. Knowing that when SPY gaps up 0.5% to 2%, we tend to continue going higher very often; I can have a clear upward directional bias for the day. I can use this piece of information to structure my entries around the OPEN price. I can trade breakout more aggressive to the upside or buying pullback after the Open with much more confident. When SPY gaps up 0.5% to 2%, my focus will be mainly on going long instead of going short.
Disclaimer: I am not a financial advisor. All information in this blog is for educational purposes only.