Gap And Crap

Living in Europe I mostly follow the index futures as the underlying cash indices only offer me mostly supplementary context during the RTH session. Although I do enjoy trading stocks and in particular their options the limited trading hours are not just challenging (and sleep depriving) for someone located in Spain but it puts strict limits to the type of activities or systems one is able to pursue as a trader. And this spells particularly true in the type of market we have increasingly found ourselves over the past few months:

Here’s a 1440min (daily) chart of the SPX cash which I have tagged with orange and green boxes. As you probably have already figured out both highlight opening gaps – to the up (in orange) and to the downside (in green).

While one would expect a series of opening gaps during a downtrend and while the same isn’t uncommon on the way up, I couldn’t help but marvel on the number and frequency of the opening gaps that have accompanied the current rally.

I have not taken the time to calculate how many of the gaps are responsible for how much of this advance but on simple visual inspection I’d wager that the number probably ranges between 20% – 30%. Note to myself: write an indicator that plots opening gaps and run some statistics on the them.

Now clearly this is not something that would bother the average institutional traders or even most of the intrepid regulars that frequent this blog. But to a retail rat with a small trading account who’s unable to put up a lot of margin an equity market full of opening gaps represents a clear limitation and most likely a significant source of recurring frustration.

What To Do?

The solution to get around this problem basically boils down to these two options:

• Reduce your trading window: Trade intraday and exit at the end of the session if your account permits frequent executions (day-trading regulations limit the number of executions permitted for accounts < $50 if I recall correctly). The challenge here however is that you may have to explore completely different types of systems, e.g. mean reversion, swing trading, or even scalping, as much of the post gap price action lately has been non-directional.
• Extend your trading window: Do the opposite, trade on a daily or weekly basis and omit all the noise. This of course is an entirely different type of game as you most likely will be using daily or weekly charts for your entries, exits, and campaign management. Everything slows down but a benefit is that you end up dealing with a lot less volatility.

Here’s the hourly E-Mini contract and as you can see realized volatility has remained rather contained. Which stands in direct contrast with what I just presented above, doesn’t it? And of course there’s a reason for this as much of the recent advances higher launched overnight or an hour or two before the opening bell.

This in turn then produces a flurry of activity right afterward and it’s easy to see on the 5-min and 1-min Zero panels. Many times participation drops significantly an hour or two later after which the bots take over.

The end result of this is a LV advance on the daily and weekly panels but a rather challenging high volatility situation on an intra-day basis.

How have you adjusted to recent market conditions? Most of you are based in the U.S. and unless you’ve been trading the futures this is something that I’m sure has not escaped your purview.

Okay, time to spoil my subs a little:

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