Gap Trading Strategy: Play the Open

Overview

A gap is a discontinuity between yesterday's close and today's open. Gaps are driven by overnight news, earnings, or order imbalance, and they fall into three types: breakaway (start of a new move), runaway (continuation), and exhaustion (final thrust). This strategy classifies the gap and trades it — fading exhaustion gaps, following breakaway gaps.

Setup

• Instruments: liquid stocks, index futures, ETFs
• Timeframe: daily chart for the gap, 5-minute for entry
• Indicators: the prior day's close, support/resistance, ATR(14), volume
• Market regime: any — gaps form most often after earnings or macro events

A gap is significant when its size is at least 0.5 × the average daily range (ATR).

Entry rules

1. Identify the gap: today's open is materially above (gap up) or below (gap down) yesterday's close
2. Classify the gap:
   • Breakaway: gaps out of a consolidation with volume — follow it
   • Runaway: gaps in an existing trend with volume — follow it
   • Exhaustion: gaps after an extended move on low follow-through — fade it
3. Breakaway/runaway: enter in the gap direction after the first 5-minute pullback holds
4. Exhaustion: enter against the gap after price fills back through the gap zone

Stop loss

• Stop beyond the gap's extreme — below the gap low for longs, above the gap high for shorts
• Maximum stop: 1 × ATR(14) from entry
• Exit if price closes back through the gap midpoint — the gap is filling

Use the stop loss calculator to set the distance.

Take profit

• Breakaway/runaway: target the measured move of the prior base, or trail with the 20 EMA on 5-minute
• Exhaustion: target the prior day's close (gap fill)
• Aim for a minimum 2R

Confirm with the risk-reward calculator.

Risk management

• Risk 1% of account equity per gap trade
• Position size = risk amount ÷ (entry − stop). Verify with the position size calculator
• Trade only one gap per morning — correlated gaps count as one risk
• Avoid gaps smaller than 0.5 × ATR; they are noise, not opportunity

When it fails

Gap trading fails when the gap is misclassified — fading a breakaway or following an exhaustion gap. Volume and the prior context decide the type. If the first 30 minutes show no follow-through in either direction, the gap is uncommitted; stand aside rather than guess.