Trading the DAX opening gap

pro trading system main content
Head straight for the introduction (or scroll down for article PDF, video presentation and powerpoint PDF)

View full article table of contents if you are on the main homepage

To download a PDF version of this article for saving or printing, click on the pdf icon below (opens in a new window).

pro-forex-trading-course-sell-limit-orders

go to first figure in article

Freddy FastTrack
Left-click on Freddy FastTrack for his Favourite pro trader trading quote from this article.
VIDEO PRESENTATION
-BASED ON THIS POST (coming soon)

PRESENTATION HANDOUT IN PDF FORMAT WITH SPACE FOR NOTE-TAKING (opens in a new window – coming soon)

Introduction

Just a quick share for members and non-members alike, pointing out the possibilities of trading a gap down to its open.

Gap size

This morning, the German DAX cash index opened with a gap of about 20 DAX points.

There was no commensurate overnight up-move in the S&P500 CFDs, which might indicate risk-on sentiment and a strong move up in advance.

Post-gap action

From 7am London time, the market continues to advance away from the gap, with some technical signs of overheating.

First sell order

In the first order, a sell stop is placed to sell the market at 12467.2 just before 8am London time. The market continues to advance, so this order is not filled and is cancelled.

At precisely 8am London time, the latest 5 minute candle shows strong bullish candle, but which again shows technical overheating, and several of the other timeframes are also showing such overheating.

In this case, the overheating indicator confluence happens to be the Commodity Channel Index (CCI) set to 5 periods, and the overheating level is 167.

Second sell order

A sell stop is placed just below its high, at 12477.5, with a tight 4 point stop loss and a take profit of 12445.5. The stop loss is promptly hit, which is to be expected with such high reward trades.

In this case there was an additional 0.2 points of slippage, taking the loss accrued to 4.2 points – not exactly a bank breaker!

The idea here is to accept small losses, but to stay in for the big winning trades.

Third sell order

We will have one more try, the order being set to enter again, after the doji just below its open and just below the high of the overheating candle before that, an aggressive sell stop entry entry of 12378.35.

NB In the Quantisi Ltd. trade plan, which I will be making commercially available via this blog, a maximum of 3 units or 3 tries at any one given trade is the absolute maximum, and sticking rigorously to the risk management strategy is as always, essential.

Sell stop order filled

Figure 1, below, shows the trade having been placed. The entry is shown by the green dot-dashed line at 12478.35 (bid – filled), the stoploss is just 3.15 DAX points above that at 12481.5 (ask), allowing 2.15 pips of upward movement over and above the 1 pip of broker’s spread factored in.

This is an exaggerated tight stop, however, for the purposes of this trade it worked fine. The reason for the extreme tight stop is the desire to obtain a very good risk reward ratio, especially since the first trade did not work out and this is chance 2 out of a potential 3.

Figure 1. The DAX gap trade several minutes after being filled

Trade risk management parameters

The take profit is at 12455.9 (ask). Therefore 3.15 pips are risked (including broker’s spread) while a reward of 22.45 pips are sought. This includes 7 x 3.15 pips and an additional 0.4 pips to account for negative slippage on the trade.

This is actually a very conservative target, given that the gap trade normally seeks to fill the gap itself (see also figure 4). What we are actually targeting is the opening candle after the gap, so it seems a very reasonable target since many gaps seek to be filled. More on identifying specific types of gap and what to expect from them in stock index trading in another post.

The precise risk to reward ratio of the filled trade is 1:7.127, or rounded down, 1:7, more than satisfactory given the 1:2.5 minimum advocated in our trade plan rules.

Figure 2 shows the evolution of the trade, and indeed when the price has hit the take profit (buy limit) level, the order is filled, and in fact, we are granted the treat of positive slippage of a luxurious 2.2 points – another good reason to use our recommended brokerage.

Take profit (buy limit)

Figure 2. Take profit order filled.

Figure 3 shows the three main order sets mentioned, the first the trade that was not filled and cancelled, the second which resulted in a stop loss being hit, and the third successful 1:7 risk to reward trade, with the final risk reward being 1:7.825 – a great result.

Figure 3. Order sequence and results from trading platform

Figure 4 demonstrates clearly how this was a low risk, high probability trade, whereby the market itself has actually gone on to fill the gap after a potential energy – kinetic energy correction – impulse sequence.

Figure 4. Filling of the DAX opening GAP on the M5

DAX Gap Trade: Discussion & Analysis

Technical indications

Rarely does ‘top guessing’ offer benefit to the trader, except in the case of opening gaps, and/or high level confluence clusters which offer reasonable limit order entry solutions.

CCI overheating

A forthcoming post will detail the use of the commodity channel index (CCI) in much more detail. For now, the key to the chart is that the red arrow ‘caps’ above the candles indicates that the relatively longer term or trend CCI (in this case set to 15) has ‘overshot’ to a level of 280 or above (in the case of upward momentum, -280 in the case of downward).

Three of the red caps in a row often indicate an imminent correction or reversal.

The white ‘caps’ on the candle tips are an indication of the period 5 CCI having hit its ‘overheated’ or ‘overshot’ mark of 167 (166.6 recurring).

Divergence on the RSI-7 indicator

The RSI-7 indicator is in the second indicator window off the chart. Divergence means that while the price has risen, the RSI has fallen, or while the price has fallen, the RSI has risen (classic divergence). This is seen as white trendlines on the chart.

As can be seen, there were two clear divergence set ups, the second, more steep divergence right before our second entry, and which acted as the guarantor of the reversal.

Reversal candle

Probably the perfect entry was at the close of the 8.05 AM London time candle (marked 10.05 on the chart) because this was a ‘normal reversal’ candle. Our aggressive entry used ‘reversal condition 2’ – which will be discussed in another post – and refers to a break below the high of the candle previous to the prior candle (i.e. at time minus two periods, t-2), in a down reversal, or a break above the low of the candle previous to the prior candle (i.e. that at t-2) in the case of an up reversal.

Stochastics & WPR_MA

Although they were not really utilised in the trade, note that the stochastics were in a prolonged overheated mode above 85, and the WPR_MA WPR (William’s Percentage Range (21) with moving average (8)) lines were beginning their descent towards their average, the top and bottom versions offering multiple timeframe analysis – M15 and M5 in this case.

Conclusion

Summary of trades

This trade used knowledge that an opening gap is often filled with a range of indications of a reversal. The first trade was cancelled due to a continuation away from the gap. The second trade failed. The third trade, similar to the second, succeeded in following through, for a 1:7.8 risk to reward. Therefore 1 unit was lost, and 7.8 gained.

Learning points for trading journal

The initial trade exceeded the 1:7 risk reward by double, simply by filling the gap. Consider in future 2-3 units with a more reasonable stop, e.g. double or three times the stop used in this trade, closing out 1-2 at the first target, or 1 at the first target, 2 at the second target (twice the height of the first rectangle shown in figure 5), stop to breakeven, and 3 with a trailing stop to let the market run.

Target 2 projection

Figure 5. Projection of height of the first swing above the gap in the downward direction.

In figure 5, the height of the first swing above the gap is taken as 34 DAX points (the green rectangle shows this until it is broken to the downside.

The height of this move is then projected downwards as a further move of 34 DAX points, providing a second target.

About the author

Dr Samuel Alexander Beatson gained his PhD from the Research Centre for Banking & Finance at the University of Nottingham in 2015. He has taught financial markets analysis for more than ten years, including during a two year position at King’s College London, as a researcher and fellow at the Lau China Institute. He is the head of trading and market analytics at Quantisi Ltd.

Freddy FastTrack’s FastTrackForex.com quote of the day

The idea here is to accept small losses, but to stay in for the big winning trades.

Top 3 Trading Moments from this trade

FREE PDF version of this article is available for saving or printing, click on the pdf icon below (opens in a new window).

DAX opening gap trade M5

To cite any part of this article, use the following citation information: Beatson, Samuel A., "Trading the DAX opening gap," in Forex, Commodities & Stock Index Analysis by Dr Sam Beatson, May 2, 2017, http://www.fasttrackforex.com/2017/05/02/trading-the-dax-opening-gap/. Accessed online on October 21, 2017.

Back to intro

Coming soon... signals every day. Pepperstone Group Limited

The strength of the USD against the Canadian dollar this week and revisiting the DAX

The USD has rallied agains the Canadian this week, helped in some part by the FOMC announcements earlier. Here is a M30 technical chart of the pair.

In the last post I mentioned trading the DAX and using trend envelopes, courtesy of my good friend and a legend of a trader, valeofx from the forex-tsd forum aka Hercs.

As a follow on from that trend which was held in place by the M30 trend envelopes. Here is a chart of today’s action.

As can be seen, the trend envelope on the M30 chart (displayed – Mauve line) and its accompanying 21EMA set to high/low/close acted as strong support for a continued rally, which was firmly corrected, possibly due to DAX December options expiry being today.

Today, the price reached and exceed the resistance 1 pivot level (R1), but closed just above it, before a 50+ point sell off. I favour further bullish activity today, since there is a failed hammer reversal (3rd bar in from the right) and indeed the failure shows a 1 bar reversal (2nd bar in from the right has a lower low, but a higher close than the hammer candle). I’m not holding out, but I think it will go up some more before the close of day. NB. This is educated guessing and not investment advice.

Coming soon... signals every day. Pepperstone Group Limited

Technical Studies on the DAX unlikely to be found anywhere else

Without doubt my chart and trade of the day is this entry marked on the 15 minute chart on the DAX.

The indicators

  • Pivot points are shown.The MR1 line (red dashed) R1 line (red solid), MR2, R2, MR3, R3 are the only pivots that can be seen.
  • The ‘channels’ are in fact an interesting combination of exponential moving averages
    • A 21 exponential moving average set to close the white dotted line
    • Above and below the exponential 21 MA set to high and low, respectively
      • Notice how when a candle has closed ABOVE the 21EMA(HIGH) the 21EMA(LOW) changes to the MAUVE solid line
      • Notice how when a candle has closed BELOW the 21EMA(LOW) the 21EMA(HIGH) changes to the MAUVE solid line
        • In my trading circle we call this a ‘Trend Envelope’
    • The exact same ‘trend envelope’ setup is transposed from the 30 minute chart onto this 15 minute chart – but it could be set up by flicking between the two charts (colour orange)
    • A 55 EMA is in grey (solid)

Ignore the CCI panel for now.

You will see a fast moving relative strength index (RSI) indicator on the indicator window on bottom.

The analysis

(i) Note how well the M30 trend envelope has ‘held’ – acting as support

(ii) Coming down through the mauve trend envelope (left side of graph), price has bounced off the M30 trend envelope – this is the clue.

(iii) Bouncing off the orange trend envelope, we see 3 bullish black candles, which form a ‘3 bar reversal’ – the third bullish candle takes out the 3 preceding highs.

(iv) The 3rd candle is strong and bullish, and also the 55EMA is turning up and seems to be holding

(v) The RSI7 has moved through the 50 line

(vi) The green dashed line marks my entry, but one could have waited for the break of the M15 trend envelopes for confirmation.

(vii) A beautiful upmove ensues.

That’s all for now.

Have a terrific Friday,

Sam.

Coming soon... signals every day. Pepperstone Group Limited