Gap Mean Reversion

Entry Logic

• Long Entry: Stock gaps down significantly and finds support.
• Short Entry: Stock gaps up significantly and finds resistance.
• Confirmation: A reversal candle on the 5-minute chart in the first 30 minutes of trading.
• Timeframe: 15-minute for context, 5-minute for entry.
• Location: At a key support or resistance level.
• Market Condition: Any.

Exit Logic

• Profit Target: A 50% retracement of the gap.
• Scaling Out: Exit 50% at the 50% retracement level, trail the rest.
• Trailing Stop: A bar-by-bar stop.
• Signal Failure: Exit if the stock makes a new high/low against the trade.
• Opposite Signal: Not applicable.
• Time Expiration: Exit by midday if the target is not hit.
• Momentum Loss: Exit if the gap fill stalls.

Stop Loss Structure

• Hard Stop: Below the low of the day (for longs) or above the high of the day (for shorts).
• Soft Stop: If the stock fails to move in your favor within 30 minutes.
• Max Dollar Loss: $700.
• Max Percent Loss: 1.4%.
• Structural Stop: The high/low of the day.

Risk Management Framework

• Risk Per Trade: 1%.
• Daily Limit: 2 trades.
• Weekly Limit: 4%.
• Max Drawdown: 12%.
• R:R Requirement: 2:1.

Position Sizing Model

• Sizing Approach: Fixed fractional.
• Volatility Adjustment: Adjust size based on the size of the gap.
• Conviction Sizing: No.
• Scaling In: No.
• Scaling Out: Yes.

Trade Filtering

• Market Conditions: Best on days with a clear gap caused by overnight news.
• Setups: Look for a gap into a key level.
• Instruments: Liquid stocks that are gapping.
• Time Restrictions: First hour of trading.
• Chop/News Avoidance: The trade is based on news, but avoid trading if the news is truly transformative for the company.

Context Framework

• Trend Direction: Counter-trend to the gap.
• VWAP Relationship: The trade is often a fade of a move away from the pre-market VWAP.
• MA Relationship: The stock is likely far from its moving averages.
• Range Location: At a new daily high or low.
• Higher TF Alignment: The gap should be into a key level on the daily chart.

Trade Management Rules

• Breakeven: After a 1R move.
• Scale Out: At the 50% gap fill.
• Add Size: No.
• Fast vs Slow Moves: This is a strategy for fast, emotional moves at the open.

Time Rules

• Optimal Window: First 30-60 minutes of the trading day.
• Times to Avoid: The rest of the day.
• Session Notes: A classic morning trading strategy.

Setup Classification

• A+ Setup: A large gap into a major daily support/resistance level with a clear reversal candle.
• A Setup: A gap into a minor level with a reversal.
• B Setup: A gap that stalls but does not reverse strongly.
• C Setup: A gap that continues to run in the direction of the gap.

Market Selection Criteria

• Instruments: Stocks on the daily gappers list.
• Volume: High.
• Volatility: High.

Statistical Edge Metrics

• Win Rate: 50%.
• Avg Win: 2.5R.
• Avg Loss: 1R.
• Profit Factor: 1.75.
• Expectancy: +0.375R.

Failure Conditions

• Market Conditions: A true trend day where the gap is just the beginning of the move.
• Specific Scenarios: A stock with a major earnings surprise or other company-specific news.

Psychological Rules

• Discipline: Must be willing to take a position against the strong initial momentum.

Advanced Components

• Regime Detection: Not applicable.
• Filters: Filter for gaps that are between 3% and 10% of the stock's price.
• Correlation: Be aware of the overall market direction.
• MTF Alignment: The daily chart is key for identifying support and resistance levels.

Location

• Strongest: When the gap is purely emotional and not based on a fundamental change.
• Weakest: When the gap is caused by a major, permanent change in the company's outlook.