Trading strategy: Gap reversal

Description

The Gap Reversal strategy was first described by trader David Pieper in Traders magazine. It is a swing trading strategy. The strategy is usually applied to stocks and futures in a trend.

The strategy in detail

The Gap Reversal strategy is based on a precise chart pattern. As the name indicates, this chart pattern includes a gap. The strategy is applied on a 1-day chart.

The strategy only generates buy signals. The signals are filtered by means of a moving average before they can be accepted.

When to open a position?

The following chart pattern must occur:

• A gap down appears. The strategy defines a gap as a difference of at least 1% between yesterday’s close and this morning’s open.
• The close price of the gap candle must be above its open price.
• The close price of the gap candle must be above its mid-price.

But not every pattern occurrence is a buy signal. The Gap Reversal strategy applies a filter based on the 250-day moving average. Only if the market price is above this moving average, a signal is validated and accepted.

When to close a position?

The Gap Reversal strategy uses a trailing stop order and a target. Both are based on the ATR. The initial return/risk ratio is set to 1.

This example shows Coca-Cola. The chart pattern meets the criteria and the market price is above the blue line indicating the 250-day moving average. The target is reached and the position is closed with a profit. Notice the ATR-based trailing stop order which follows the market price.

This example shows Boeing.

This example shows Apple. The trailing stop is reached and the position is stopped out with a loss.

This example shows the Dutch market index, AEX.

Conclusion

The Gap Reversal signals appear to be of good quality but they are relatively rare. Hence the most efficient way to detect them is to use the screener.

The chart pattern used in this strategy is also available by itself in the trading platform in the WHS Patterns folder. The platform also contain a ready-to-use screener based on the chart pattern.

Practical implementation

Using the NanoTrader Full follow these steps:

• Select the financial instrument you wish to trade and open the chart.
• Select the template study "WHS Gap Reversal" in the "WHS Strategies" folder.
• If necessary, adapt the settings as described above.
• If you want to trade semi-automatically, activate TradeGuard+AutoOrder in the chart. If you want to trade automatically, activate AutoOrder in the chart.