Opening gaps have been mentioned previously as something to watch out for. You might hold an open bet overnight, and think that you have your downside covered by having a stop loss order, but the market can fool you and jump away from the previous day’s trading range, leaving you with a much larger loss when the bet is closed on your stop loss order than you had anticipated. Remember that the stop loss order simply becomes a market order when the conditions are met, so you will get whatever price the market is then trading at.
But there are different types of opening gaps, and not all are the start of a reversal. It depends on the situation of the particular financial security, and you must rely on technical analysis for an indication of the underlying market sentiment. For this to work you will need to be quick, as when gaps are filled it usually takes much less than the first hour of trading. So first, you should identify what you think the gap is going to do, based on the market sentiment which technical analysis is showing you.
Start of a reversal
The gap may herald the start of a reversal. It is a strong indication if the technical indicators show that the market has become over- or under-sold that the counter-trend move is under-way, and that you can expect the other traders to jump on board quickly and surge the price further away from the previous day. If the oscillators are showing that the correction is due, then it is reasonable to place a bet in support of that.
The other view is that the gap is just a market fluctuation. Some gaps are the vagaries of the market, and will soon be filled, and another intra-day strategy can be to look for this at the opening of the market. For this to be the case, the security should be in a trend, with no reversal indication. In this sense, the gap may even look as if it is unexpected.
If you feel that this is the indication of market sentiment, then you can place a bet that the price will come back and fill the gap values. From there, you would do well to keep a close watch on the price action. Remember that the gap can provide support or resistance levels, so if the price is trading in the range of the gap you may see a reversal when it reaches one extreme.
When you are betting on gaps, as you can see the price has the possibility of going either way. What you do know is that the gap indicates a lot of interest and potential price movement, so all you have to do is figure out the market sentiment in order to profit from it. You need to keep a tight stop loss position to minimise your downside on the occasions that the price does not perform as expected, and even when it does you should move your stop loss position to guard against retracement.