Prediction Wizard

In investments and in trading risk is very important aspects of our market participation.

Overnight traders, swing traders and investors must accept  the overnight risks, that the market poses.

One aspects of the overnight risks is the GAPS, that the  market presents at the regular market open  in those instruments, not traded  24 hours a day.

Day traders also impacted when formulating their market participation strategies  depending upon the GAP  at the market open.

To help formulating those strategies  we would like to know what happens after  those GAPs.

For us the pointers  in many cases are in the form of probabilities, so we  created some studies to find out what can we expect after a GAP.

First  to define a GAP, we present the following image, which consists of two candles:

The GAP is between the Close of the first candle and the open of the second candle.

The GAP percentage  can be calculated as follows:

GAP [%] =  ABS((C2.Open – C1.Close) / C1.Close * 100)   [%]

The actual GAP is a GAP Up, if C2.Open is greater than C1.Close, or a GAP Down if the C2.Open is  below C1.Close.

One important aspects that we would like to know,  is  related to the retracement of the GAP during the market day.

We say  that a GAP 100 [%} retraced, If the  market  GAPs Up today and moves below the close of the previous day or GAPs down Today and moves above the Close of the previous day.

The following table presents some of the results of our study, that we created about GAP  retraces.

For the study we used the daily data of the NASDAQ100 index – following ETF symbol, the QQQQ. Similar results could be attained for the S&P500  index following  SPY symbol.

We created four categories of  GAP sizes, and four categories of GAP retraces.

First column in the table presents the probabilities, that the market retraces at least 38 [%] of the GAP.

The second column in the table presents the probabilities, that the market retraces at least 50 [%]

The third column presents the probabilities, that the market retraces at least 66 [%] of the GAP, and the last column presents the probabilities, that  the market fills the GAP, or retraces 100 [%]  of it  sometimes during the day.

Some comments and conclusions after looking at the results:

-          Most of the time, for  smaller GAPs we have a very high probability, that the market will retrace 38 [%] or  even 50 [%] of those gaps,  so if we would like to play in the direction of the GAP, we do not necessarily need to hurry or can get better prices with  a little bit of patience.

-          This also mean, that in many cases  playing against the GAP right from the open  might be  a very successful  short – term play  intraday trading strategy.

In this case shooting for at least a 62 [%] retracement might have a good win probability, as the probability numbers for at least a 50 [%] retracement is only marginally bigger than the probability of at least a 62 [%] retracement. 

-          Logically , the bigger the GAP, the smaller the probability that it will be retraced 100 [%] during the day. For GAPs, above 1 [%] the probability, that it will be completely retraced during the day is only 50.6 [%], roughly  50 fifty /fifty.

This also explains, why do we have relatively little chance, if the market GAPs against the predicted direction with a bigger than  1  [%] GAP.

-          We selected the 38 [%], the 50 [%],  the 68 [%] and the 100 [%] as they are close to the Fibonacci retracement  levels. The importance of the Fibonacci numbers relatively low for GAPs, smaller than 0.5 [%],  as we have almost 80 [%] probability  that the market will retrace 100 [%] of those GAPS sometime during the day.

-          In the above study we did not take into account any other market parameters, that might have some  impact  on the actual probabilities.  Some of these could be like:

o       The direction of the SMA20 / SMA50 / SMA200 averages

o       The Information, that the daily price levels  are Above / Below these averages

o       The information, that the predictor predicted the direction  in the direction of the GAP or against the direction of the GAP.

o       Any other indicators or market data, or economic data.

Taking these into account one by one at a time we found that the difference in the actual probability might be different by 3 – 7  [%]

Now having the retracement / Fill probabilities for  different settings  as the next step we would like to get answer for the following question:

Considering, that the market retraces at least the 38 / 50 / 62 / 100 [%] of the GAP already  occurred during the day. What is the probability than, that the market  takes a 180 degree turn and  will close above the  market open  (in case of a GAP UP ) or Below the market open (In case of a GAP Down).

The following table present the results:

Some of the conclusions from the data:

-          Even after a Big GAP (Up / Down) and a 100 [%] retracement of that we still have 18.7 [%] probability, that the market turns, and turns in a big way, by moving back above the open (In case of a GAP UP) or below the open (in case of a GAP Down)

-          The probability, that the market will presents a big turn  considerably decreases, IF  we reach the previous day’s close, retracing 100 [%] of the GAP first.

Presenting a 100 [%] retracement  is like  putting  the market in a different trajectory.

-          If the market  turns  back toward the original direction of the GAP without a 100 [%] retracement, than  the actual retracement level  will have  little determining factor   for the probability of reaching the opening level. It is  roughly 40 [%]  for most GAPs, smaller than 1 [%]

    Enjoy Your Trading.