1. Using Gap Zones to Create a Profitable Strategy for the Opening Gap
Scott Andrews

2. Disclaimer This material is intended for educational purposes only and is believed to be accurate, but its accuracy is not guaranteed. Trading and investing has large potential rewards and large potential risks. You must be aware of, and fully understand, these risks and be willing to accept them in order to invest in equity, futures, options, currencies and other financial markets. Do not trade with money that you cannot afford to lose. This material is neither a solicitation nor an offer to buy or sell equities, futures, options, or currencies. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed. The past performance of any trading system or methodology is not necessarily indicative of future results. Use this information at your own risk! Copyright Notice All materials contained in this presentation are protected by United States copyright law and may not be reproduced, distributed, transmitted displayed, published or broadcast without the prior written consent of Master The Gap, Inc.

3. Overview The Basics, Promise & Dilemma Solution: Gap Zones The Math
Two Weeks in the Life of a “Gapper”
Summary
Q & A

4. Definitions
Gap – difference between the prior day close and next day’s opening price (regular session / pit hours).
Fade – to trade in the opposite direction of the gap.
Gap Fill – when price retraces from the opening back to the prior day’s close.
Win Rate – percent of gaps that, if faded at the open, filled the gap or could have been exited at the end of the day for a profit.
Profit Factor – the ratio: (profits from winners) / (losses from losers) measures the historical profitability of a given setup. This is more important than “win rate.”
“Gapper” - a unique individual that has evolved beyond his/her trading peers by recognizing the superior return on time, effort and capital of the "gap fade." This elite trader can be recognized by his/her enviable lifestyle & finances.

5. Why I Love Gaps
Gaps have an inherent bias and edge (>70% win rate).
They occur frequently (three to four tradable gaps per week in the S&P).
It's an easy trade to learn and play.
I can prepare in about 15 minutes before open.
I can trade them without charts and from anywhere.
Getting filled with minimal slippage is not an issue.
The entry and target are pre-defined so I don't have to manage the trade.
My risks are limited and controlled - no overnight risk.
They work in bull and bear markets equally well – no need to predict the market’s next move.
They occur in most asset classes and can be traded using stock, options, and futures contracts.
I can grow my account significantly with this single, simple setup & one market.
Understanding the bias of the market before and after the gap fills, provides a trading edge for the rest of the day while also helping optimize my entries on swing and position trades.

6. The Promise of Gap Fading
Year
Number of Gaps
Win %
2008*
79*
72.2%
2007
225
64.9%
2006
200
72.5%
2005
196
71.4%
2004
213
72.3%
2003
211
75.4%
2002
229
73.4%
2001
208
74.0%
2000
223
73.5%
1999
236
75.9%
1998
226
73.0%
Total:
2,246
72.4%
The vast majority of opening gaps will retrace back to the prior close at some point during the day
* January 1 - April 30, 2008
“Win %” is based upon hypothetically fading opening gaps > 1 point in the E-Mini S&P 500 futures, ,
using no stop, targeting prior close, exiting end of day if gap did not fill. This not a recommended strategy.

7. The Paradox
Year
Profit Factor
2008*
1.24
2007
0.71
2006
1.01
2005
1.05
2004
1.11
2003
1.30
2002
1.14
2001
1.16
2000
0.94
1999
1998
1.06
Average:
(yawn)
High win rate does not equate to big profits.
January 1 - April 30, 2008
Profit factor = total profits of winners / total losses from losers
Though an extremely high win rate, the profits from
the winners barely exceed the losses from the losers.

8. The Dilemma Using small stops does not improve
Stop As % of Gap Size
% Win
Average
Win/Loss Ratio
Profit Factor
25%
21.4
3.49
0.95
50%
36.0
1.80
1.01
75%
47.0
1.18
1.05
100%
53.7
0.91
1.06
125%
59.0
0.73
150%
61.8
0.64
1.04
175%
64.7
0.57
200%
66.1
0.53
1.03
Note: – 2007, E-Mini S&P 500 futures.
Using small stops does not improve
profitability due to the reduction in win rate.

9. The key to making money fading opening gaps is…
SELECTION

10. Gap size is not correlated with profitability.
Filter by “Size of Gap”?
Fading 1- 3 point gaps at the open, using a 6 point stop:
78.0 % filled or finished profitable (687/881)
Profit factor:  1.17
Fading gaps > 10 pts at the open, using a 6 point stop: 
37.5% filled or finished the day profitable (91/243)
Profit factor = 1.17
Note: based on E-mini S&P 500 futures,
Gap size is not correlated with profitability.

11. A Solution…

12. “Location, location, location”… applies to gaps too!
“Gap Zones”
High
Close
Open
Low
Definition: location of the gap
relative to the prior day’s key
price levels: Open, High, Low
and Close.
“Location, location, location”… applies to gaps too!

13. Why Gap Zones Work They inherently incorporate: Support and resistance
High
Close
Open
Low
They inherently incorporate:
Support and resistance
Short term trend
Gap size
Trader psychology

14. Gap Zone Areas Prior Day Potential Next Day Gap Areas Above the high
Below the high & above the
open or close
Between the open and close
Below the open or close
& above the low
Below the low

15. Gap Fade Win % All gaps > 1 point = 72.4 %
“Win %” is based upon hypothetically fading opening gaps > 1 point in the E-Mini S&P 500 futures, ,
using no stop, targeting prior close, exiting end of day if gap did not fill. This not a recommended strategy.

16. Gap Fade Win % By Zone 69% 76% 75% 63% Prior Day Historical Win Rate
“Win %” is based upon hypothetically fading opening gaps > 1 point in the E-Mini S&P 500 futures, ,
using no stop, targeting prior close, exiting end of day if gap did not fill. This not a recommended strategy.

17. Direction of Prior Day Should Be Considered Too
Open
Close
Close
Open
Prior day “direction” incorporates the short term trend.

18. The Math…

19. Gap Fade Win % By Gap Zone
Win % Prior Day
59%
66%
75%
78%
65%
Prior Day Win %
71%
82%
75%
72%
54%
“Win %” is based upon hypothetically fading opening gaps > 1 point in the E-Mini S&P 500 futures, ,
using no stop, targeting prior close, exiting end of day if gap did not fill. This not a recommended strategy.

20. Let’s Compare Similar Gaps in Four of the Zones…
Zone A
Zone B
Nice concept but do they really work?
Zone C
Zone D

21. Test Scenarios 3-7 point gaps Four zones: 2 long & 2 short strategies
Test 3 targets: exit end of day, gap fill, & 3 points beyond
Test “no stop” & 6 point stop
Compare win rate
Compare profit factor (pf)

22. Scenario #1: No target, no stop, exit EOD
48% win
.73 pf A B
53% win
1.27 pf
Best “fade”
candidate
Best “go with”
candidate
Nice concept but do they really work?
42% win
.51 pf
52% win
.98 pf C D
Baseline: 48% win rate, 1.0 pf (all zones)

23. Scenario #2: Target gap fill, no stop
65% win
.87 pf A B
76% win
1.11 pf
Historically
profitable
even with
no stop
Nice concept but do they really work?
68% win
.84 pf C D
55% win
.75 pf
Baseline: 71% win rate, 1.05 pf (all zones)

24. Scenario #3: Target gap fill, 6 pt stop
59% win
1.22 pf A B
68% win
1.33 pf
Using a stop made this
a viable fade candidate
Getting
very
interesting…
Nice concept but do they really work?
55% win
.85 pf C D
48%
.85 pf
Baseline: 61% win rate, 1.14 pf (all zones)

25. Scenario #4: Target 3 pts past gap fill, 6 pt stop
49% win
1.15 pf A B
58% win
1.52 pf
Now we’re
talking!
Nice concept but do they really work?
YUCK
36%
.67 pf
BLUD!
(below low of up day) C D
41%
.71 pf
Baseline: 48% win rate, 1.09 pf (all zones)

26. Most zones have a bias to fill, but some do not.
What Is Obvious?
Scenario #1
No target, no stop, exit EOD
Scenario #2
Target gap fill, no stop
Scenario #3
Target gap fill, 6 pt stop
Scenario #4
Target 3 pts beyond gap fill, 6 pt stop
All Zones
48% win
1.0 pf
71%
1.05 pf
61%
1.14 pf
48%
1.09 pf
Zone A
.73 pf
65%
.87 pf
59%
1.22 pf
49%
1.15 pf
Zone B
53% win
1.27 pf
76%
1.11 pf
68%
1.33 pf
58%
1.52 pf
Zone C
42% win
.51 pf
.84 pf
55%
.85 pf
36%
.67 pf
Zone D
52% win
.98 pf
.75 pf
41%
.71 pf
Most zones have a bias to fill, but some do not.

27. “BLUD” zone: Below Low of Up Day
Tip: Don’t Fade da’ BLUDs!
Scenario #1
No target, no stop, exit EOD
Scenario #2
Target gap fill, no stop
Scenario #3
Target gap fill, 6 pt stop
Scenario #4
Target 3 pts beyond gap fill, 6 pt stop
All Zones
48% win
1.0 pf
71%
1.05 pf
61%
1.14 pf
48%
1.09 pf
Zone A
.73 pf
65%
.87 pf
59%
1.22 pf
49%
1.15 pf
Zone B
53% win
1.27 pf
76%
1.11 pf
68%
1.33 pf
58%
1.52 pf
Zone C
42% win
.51 pf
.84 pf
55%
.85 pf
36%
.67 pf
Zone D
52% win
.98 pf
.75 pf
41%
.71 pf
“BLUD” zone: Below Low of Up Day

28. Two weeks in the life of a “gapper”…

29. How I Trade Gaps
Direction: mostly "fades" – though I do have a couple "go with" signals
Pre-market Filters: primarily on where the gap opens (i.e. gap zone)
Gap Size: totally dependent upon the zone
Decision Time: based upon where prices are trading at 9:25 am ET
Position Size: one contract for every $10,000 of equity
Risk Management: if I’ve identified one or more risk factors, then I reduce my position size
Stops: based upon points or a percentage of the gap amount, optimized by zone. I use a time-stop for some zones
Targets: before, at gap fill, or beyond gap fill, depending upon the zone
Entry Technique: at open (9:30 ET) using a market OCO (“One Cancels Other”) bracket order
Exit Technique: at my target or stop, or end of day if neither hit. I never hold overnight. I manage some positions intraday.
This ensures that I never suffer a full size loser that exceeds my max allowable money management loss on a single trade, while keeping draw-downs in a range that is psychologically tolerable.

30. Monday, April 7, 2008 Gap: up 9.5 pts
Zone: below high & above open of prior “down” day
Action: half size short at open
Result: -6 pts ($300) per contract
Time in trade: 3 hr, 25 min

31. Tuesday, April 8, 2008 Gap: down 7.25 pts
Zone: below low of prior “down” day
Action: no trade
Result: missed a winner

32. Wednesday, April 9, 2008 Gap: down 2.25 pts
Zone: below close & above open of prior “up” day
Action: short half size (“go with” trade) at open
Result: +3 pts ($150) per contract; scaled out +2.25, +3, +5
Time in trade: 28 min

33. Thursday, April 10, 2008 Gap: down 3.5 pts
Zone: below close & above low of prior “down” day
Action: long at open
Result: pts ($322) per contract, scaled out: +6 and pts
Time in trade: 1 hr, 46 min

34. Friday, April 11, 2008 Gap: down 16 pts
Zone: “BLUD” - below low of prior “up” day
Action: no trade
Result: good call

35. Monday, April 14, 2008 Gap: down 1.75 pts
Zone: below close of prior “down” day
Action: half size long at open
Result: closed at end of day for -2 pts ($100) per contract

36. Tuesday, April 15, 2008 Gap: up 7 points
Zone: above high of prior “down” day
Action: short at open
Result: pts ($215) per contract; scaled out +4, +6, and +5 pts
Time in trade: 1 hr, 29 min

37. Wednesday, April 16, 2008 Gap: up 11.25 pts
Zone: above high of prior “down” day
Action: half size short at open
Result: stopped for a full loss (-6 pts) ($300) per contract
Time in trade: 1hr, 25 min
16th of month! Options expiration week

38. Thursday, April 17, 2008 Gap: down 8.75 pts
Zone: below close, above open of prior “up” day
Action: half size, discretionary (no signal) long at open
Result: pts (+$266.5) per contract (scaled out: +6, +3, and +8)
Time in trade: 6 hr, 6 min.

39. Friday, April 18, 2008 Gap: up 19.75 pts
Zone: above high of prior “up” day
Action: no trade
Result: good call

40. Summary
The “gap fade” is a simple trade & a great foundation for a trading plan
Know the zone!
It pays to be picky
Don’t leave money on the table - know which ones to close before or beyond gap fill