Gap Trading: Profit from Overnight Price Moves

TradingView Scanner (Pre-Market Fade Setup):

TradingView Scanner (Breakaway Gap-and-Go):

ThinkOrSwim (Pre-Market Gaps > 2%):

The Setup (December 18, 2023 - Pre-Market)

• Previous Close: $246.32
• Gap Open: $252.80 (+2.63% gap)
• Catalyst: None—general market optimism, no TSLA-specific news
• Pre-Market Volume: 1.8M shares (only 1.5x average—low conviction)
• Technical Setup: TSLA in sideways range for 2 weeks, gap brings price to range resistance
• Market Context: SPY/QQQ slightly green but not gapping—isolated TSLA move

The Trade Execution

• 9:30-9:45 AM: TSLA opens at $252.80, pushes to $254.10 in first 15 minutes
• 9:47 AM: Rejection candle forms—drops from $254 to $252 on increased volume
• Entry: Short 200 shares at $251.90 (after confirmation of rejection)
• Position Size: $50,380 (2% account risk on $1M portfolio)
• Target: $246.32 (previous close—full gap fill)
• Stop Loss: $256.50 (+$4.60 from entry = 1.8% risk)
• Risk Per Share: $4.60 × 200 = $920 max loss (comfortably within 2% risk tolerance)

The Outcome

• 10:30 AM: TSLA fills half the gap, trading at $249.50
• 11:45 AM: Crosses below VWAP at $248.20
• 12:30 PM: Full gap fill—touches $246.50
• Exit: Cover short at $246.80 (50% position), $247.20 (remaining 50%)
• Avg Exit Price: $247.00
• Gross Profit: ($251.90 - $247.00) × 200 shares = $980
• Return: +1.95% in 3 hours
• Risk-Adjusted: Risked $920 to make $980 = 1.07:1 (not our best, but a win)

Why This Worked:

1. No fundamental catalyst—pure sentiment gap (high fill probability)
2. Low pre-market volume confirmed weak conviction
3. Gap brought price to range resistance (technical rejection zone)
4. Waited for confirmation (didn't short the open blindly)
5. Volume spike on rejection confirmed exhaustion
6. Exited systematically at gap fill target (didn't get greedy)

The Setup (February 22, 2024 - Post-Earnings)

• Previous Close: $674.69
• Gap Open: $735.50 (+9.01% gap!)
• Catalyst: Earnings blowout—EPS beat by 25%, revenue guidance raised
• Pre-Market Volume: 47M shares (6.2x average—massive institutional buying)
• Technical Setup: Breaking out of 3-month consolidation to new ATH
• Sector Context: Semiconductors rallying on AI demand narrative

The Trade Execution

• 9:30-10:00 AM: NVDA opens $735, immediately pushes to $748 (FOMO buying)
• 10:15 AM: First pullback to VWAP at $738 (this is the entry)
• Entry: Buy 100 shares at $738.20
• Position Size: $73,820 (will risk 1.5% of $1M account = $15k)
• Target: $790+ (riding momentum, no fixed target—trail stop)
• Stop Loss: $720 (below pre-market low of $722—invalidation point)
• Risk: ($738 - $720) × 100 = $1,800 risk

The Outcome

• 10:30-11:30 AM: NVDA consolidates $740-$755 range
• 12:00 PM: Breaks $755, momentum accelerates
• 2:00 PM: Reaches $785—move stop to $770 (lock in gains)
• 3:30 PM: Peaks at $791.30, then pulls back
• 3:50 PM: Stop hit at $773.50 on profit-taking
• Exit Price: $773.50
• Gross Profit: ($773.50 - $738.20) × 100 = $3,530
• Return: +4.78% in one day
• Risk-Adjusted: Risked $1,800, made $3,530 = 1.96:1 R:R

Why This Worked:

1. Massive fundamental catalyst (earnings beat) with clear business momentum
2. Extreme pre-market volume (6x) = institutional conviction
3. Didn't chase the open—waited for VWAP pullback entry
4. Stop below pre-market low = respected invalidation
5. Trailed stop aggressively once in profit (captured majority of move)
6. Sector tailwind (AI narrative) provided continuation fuel

1. False Breakouts (The Bull Trap / Bear Trap)

Gap appears to be breaking out, you enter, then price violently reverses and stops you out.

Example: Stock gaps up 6% on strong earnings. You buy the gap-and-go at open. Within 30 minutes, profit-taking slams it back down, triggering your stop. You lose -3.5% while the "breakout" fails.

Prevention: NEVER buy the open on gaps > 5%. Wait for first pullback to VWAP. If price can't hold VWAP, the gap is false. This single rule prevents 70% of false breakout losses.

2. Earnings Gaps (Unpredictable Volatility)

Earnings gaps are the most dangerous—options market makers manipulate, algos whipsaw, retail gets destroyed.

Stats: Earnings gaps have only 52% directional accuracy after first hour (coin flip). IV crush kills options traders. Price action is erratic.

Rule: Avoid trading gaps on earnings day unless gap is > 8% with massive volume AND you wait for first 1-2 hours of price discovery. Otherwise, sit out.

3. Market-Wide Gaps (Correlation Kills Fade Setups)

If SPY/QQQ gap in the same direction as your stock, individual gap-fill probability drops dramatically.

Data: When SPY gaps > 1% and AAPL gaps 2%, AAPL's fill probability drops from 81% to 43%. The market tide overwhelms individual reversion.

Filter: Before entering fade-the-gap setup, check: Is SPY/QQQ gapping > 0.5% in same direction? If yes, skip the fade or reduce position size by 50%.

4. Trend-Confirming Gaps (Don't Fight the Trend)

Stock in strong uptrend gaps up 3%. You fade it. Stock continues higher. You get crushed.

Example: NVDA in Jan-March 2024 had 7 gaps > 2%. All continued higher (trend-confirming). Fading any would have lost money.

Check Before Fade: Is stock above 20-day, 50-day, AND 200-day MA? If yes, don't fade gaps in trend direction. Either trade with trend or skip.

5. Low Liquidity / After-Hours Manipulation

Thin after-hours volume creates fake gaps that vanish at open, or worse—widen further.

Trap: Stock shows 4% gap at 7 AM on 50K volume. You plan to fade. Market opens, real volume floods in, gap expands to 6%.

Safety Check: Only trade gaps on stocks with average volume > 5M shares/day. Verify pre-market volume is at least 200K shares before making decisions.

1. Trading The Gap At The Open

Mistake: Seeing a 3% gap and immediately entering at 9:30 AM without confirmation.

Fix: Wait 15-30 minutes. Let the gap "declare itself." Does it hold and build? Fade it. Does it reject immediately? Wait for retest. Patience adds 19% to win rate.

2. Ignoring Volume

Mistake: Fading a gap without checking if volume supports or contradicts your thesis.

Fix: Volume < 2x=fade opportunity. Volume> 3x = follow momentum. This is non-negotiable. Volume tells you institutional intent.

3. No Stop Loss / Wide Stops

Mistake: "I'll wait for the fill" as gap expands against you to -8%.

Fix: Set stop at 1.5x gap size for fades, or below pre-market low for gap-and-go. If thesis breaks, exit immediately. One -12% loss wipes out four +3% wins.

4. Forgetting To Check The Catalyst

Mistake: Fading a 4% gap without reading why it gapped.

Fix: ALWAYS check news before entering. Benzinga, Twitter, company IR. Takes 60 seconds. If there's a major catalyst, don't fade—consider gap-and-go instead.

5. Holding Too Long (Overstaying The Trade)

Mistake: Gap fills 80%, you hold for 100%. It reverses, you exit at 40% fill.

Fix: Take 50% profit at 75% gap fill. Trail stop on remainder. Gap trading is a scalp, not a swing trade. Most fills happen within 2-4 hours.

6. Trading Low-Quality / Illiquid Stocks

Mistake: Finding a "perfect" 5% gap on a $400M market cap stock with 300K daily volume.

Fix: Only trade stocks with market cap > $5B and volume > 5M shares/day. Liquidity = reliable fills and less manipulation. Quality over quantity.

7. Not Tracking Performance By Gap Type

Mistake: Treating all gaps the same and not learning which setups work for YOU.

Fix: Keep a trading journal. Track: gap size, volume, catalyst, fill %, hold time, profit. After 30 trades, you'll see your edge clearly. Double down on what works.

1. Options Market Intel

Before trading the gap, check the options market for hidden signals.

• Put/Call Ratio: High put buying during gap-up = smart money hedging (fade signal)
• Implied Volatility: If IV drops after gap, market expects consolidation (fade setup)
• Unusual Options Activity: Large call buying during gap-down = institutions accumulating (reversal coming)

Tool: Use Unusual Whales, Flowalgo, or ThinkorSwim's Sizzle Index to track this.

2. Level 2 Order Book Analysis

Watch the bid/ask during first 15 minutes of gap. Where is size accumulating?

Bullish Signal: Large bids stacking up below current price during gap-down = institutions buying dip
Bearish Signal: Large offers above price during gap-up = distribution, fade the gap

3. Relative Gap Strength (Pairs Logic)

Don't just trade absolute gaps—trade relative gaps within sectors.

Example: If entire tech sector gaps down 2%, but MSFT only gaps down 0.8%, MSFT shows relative strength. When sector bounces, MSFT will outperform. Go long MSFT, short weaker name like INTC.

Edge: This is market-neutral mean reversion—you profit on spread convergence regardless of market direction.

4. Multi-Timeframe Gap Confirmation

Check if gap is significant on multiple timeframes: daily, weekly, monthly.

High-Conviction Setup: Gap that breaks through weekly or monthly resistance/support = institutions repositioning. These gaps don't fill—they continue. Don't fade these.

Low-Conviction Setup: Gap that's only significant on daily chart = noise. High fill probability.

Avoid These Situations

• Earnings day gaps (unless experienced)
• Gaps on low-volume stocks
• Market-wide gaps (correlated moves)
• Trend-confirming gaps (don't fight trend)
• After-hours manipulation (thin volume)
• Small-cap/penny stocks
• Gaps > 15% (too volatile)
• Multiple gaps in same week (exhaustion)
• VIX > 35 (crisis mode)
• Your track record shows losses in this gap type

Expected Performance Metrics (Fade-the-Gap)

Gap-and-Go Metrics

Based on backtested data (S&P 500 stocks, 2010-2024). Gaps between 2-5% with proper volume filters. Past performance doesn't guarantee future results.