Saturday, October 27, 2007

How I Trade Gaps

The Qs got a boost Friday, thanks largely to MSFT stellar earnings. The overnight futures told of the coming pop, and the real question was . . .should I fade the open or wait for the classic trap door set up. If not familiar with the trap door, mosey over the cucca's site and browse around for a description. I use Schwab's SteetSmartPro platform, which actually is Cybertrader, and the lower black background charts are 2 of the 6 charts that I monitor throughout the day to trigger my entries and exits.
Both the TICK and NYAD charts have only a few indicators: pivot points, MACD signal line (on the chart) set at 5,20,3 which is the single line moving average component of the MACD, and a MACD histogram, again set at 5,20,3 in a lower study window of each chart. Since I'm a visual guy and react to pattern recognition, the histograms provide a simple way to monitor the pulse of the market. The NYAD is also set with a parabolic SAR.
What these two charts tell me at Friday's open is twofold:
1. The TICK chart histogram stays below the zero line and the baseline PP pivot at the open. This tells me that contrary to the wild pop at the open, there doesn't appear to be much momo behind it and the likely next move will be down. BUT, I don't want to get slammed in the butt by the trap door, so I'm not quite ready to sell those naked calls yet. . .
2. The NYAD, which serves as my confirming indicator, does show some strength at the open, rising from the PP open to a level of about R3 in a about 6 minutes where a doji forms, followed by a engulfing solid (red) bar 2 minutes later, which is my trigger to go net short. Immediately following the entry, the signal line turns down and the MACD histogram falls below the zero line. . .giving me some confidence that the entry was correct. I also have the parabolic SAR (pink dots) on the NYAD, but this indicator does not give reliable gap entries and is best used in a 5 or 8 minute bar setting (more on that later).
The TICK histogram actually stayed below the zero line until 12:15, (not shown) when both the parabolics and the MACD signal line flashed a reversal signal, and I exited. I contemplated going long at this point, but because of a pending medical appt. in 2 hours, and since it was Friday, decided not to risk the exposure.

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