I suggested a trading strategy on Friday before the market opened: buy a breakout of the 90 minute range if the open-gap failed to close in the first 90 minutes. What I’d like to consider today is why I’d sell the open-gap on Thursday and look to buy Friday’s.

The short answer is context.

Assessing context is a critical skill for a discretionary trader. In my view, it is a skill that is being lost. The fading of a gap-open is a well-known strategy for the S&P; but the question always is: is this the correct strategy to apply in this context?

On Thursday we gapped up 10 points from the Wednesday close at 4:00 PM EST. Note that the Thursday open was contained by the boundaries of congestion that had been established in the preceeding few days. Note also that as soon as the market opened on Thursday, we saw selling volume come in. 

The volume profile showed that the attempt to move higher from the open of 1474 on Thursday took place on non-existent volume and indeed, we saw no buying volume come in until 1471. This suggested that the market would extend the range of the initial balance to the downside - with a minimum target being the previous day’s volume value area at 1461.5 and the probable target being the previous days’ second standard deviation at 1458 to 1456.

On Friday. the market gapped 17 points from the 4:00 PM close. Such a strong open ought to have been met by strong responsive selling. Instead we had the reverse of Thursday. The initial down move in the “A” period (9:30 to 10:00 am) was on relatively light volume and this story repeated itself until the ‘J” period.  There was a distinct lack of selling enthusiasm.

The key differences between Thursday and Friday were:

  1. The location within the sidways structure that the market gapped into. On Thursday, the market gapped within the sideways structure and into the sell zone. On Friday, the market gapped above the sideways structure.
  2. The response as evidenced by the buying/selling volume on Delta. On Thursday, the responsive seller came in quickly; but there was no sign of the seller on Friday.

It’s important to note that there were important similarities on the two days: similarities that may be distiguishing differences next time:

  • The market was coming off a rejection low of the Primary Buy Zone
  • There short term behavioural parameters were giving buy signals
  • The Ray Wave was looking for a new high
  • The seasonal tendencies favoured a year-end rally.

Identification of an edge is important; but even more important for a discretionary trader is identifying the context that increases or decreases that edge.

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