Last night, the ES futures open-gapped about 5.27%. In his blog yesterday, Quantifiable Edges, Rob Hanna produced a table of occurrences where the S&P gapped more than 2%.

Based on that table, we can say there is a 75% probability the gap will close within 2 days i.e. by today and an 85% probability it will close within 3 days. If we couple this info with the Ray Wave and the 60 mins/90 mins gap rule, you have the makings of a possible trade. Should the market not close the open-gap after 3 days, it will indicate the rally may be stronger than I think it is.

Here are my ideas on the possible trade.

• The 18-d (monthly trend) & 13-w (quarterly trend) are down and are likely to continue down.
• The strategy therefore is look for a place to go short.
• Figure 1 shows that if the current 5-d structure (weekly trend) is to hold, we need to see prints at or below 1022.75. The lower boundary of the Wave 4 zone is 960.80.
• Figure 1 also shows the 38.2% retracement level coming in at 1010.55 and within the Wave 4 target zone.
• If the structure is to give way, we’ll see a print above 1022.75. So logically, the stop would be above 1022.75

FIGURE 1 S&P 10-13-2008

• Your entry would be somewhere between 960.80 to 1022.75. The target based on the current spread with cash is 869 to 770. See Figure 2 for the Primary Buy Zone target
• You’d calculate the entry based on your expectancy return and historical risk:reward.

FIGURE 2 S&P 12-M

Acceptance above 1022.75 raises the possibility that we have seen the bottom of the down move. More on this tomorrow.

If tonight the market gaps above 1022.75. then I’d apply the hourly rule:

• If the market fails to cover 50% the gap in the first 60-minutes (90-minutes if the 60-minute fails to cover at least 50% of the gap but closes on its highs), I’d sell when Market Delta shows a volume top or on a breach of the 60-minute low.
• I’ll leave the stop to your imagination.
• The profit exit 1/2 at 893.75, 1/2 at 1017.75 or close of trading on Wednesday.

The exits are based on exiting on a close of the open-gap for yesterday within 3-days of the gap. If Monday’s gap does not close, the market is stronger than I think and I’ll exit all shorts by end of trading Wednesday (Rob’s research).

I would not go long on a gap-open today (10-14-2008).

PS: This blog is not to be taken as imparting investment advice. I am showing you my process of thought. Indeed for reasons publicly stated, I am not trading the ES given its current volatility.

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