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posted on 22 April 2016

The Opening Gap

by Sam Seiden, Online Trading Academy

Online Trading Academy Article of the Week

Over my more than 20 years of experience trading the financial markets, I have learned many things. One big one has to do with trading around the market open. Some say this is high risk and others say it's the best opportunity of a trading day. I would suggest they are both right.

Someone always says: "I was told we are not supposed to trade the open because it is not for the novice trader." That is not exactly what we say at Online Trading Academy. What we say is that the open is not for the novice trader. It is, however, a fantastic opportunity for the astute trader who knows how to identify a key supply and demand imbalance in the markets and how to identify novice buying and selling. Most of the time, our entry is within seconds to minutes of the opening bell. There is a reason for this...

Why do prices gap up? They gap up because there are more willing buyers at the market open than there is available supply at the prior day's closing price. They gap down because there is more willing supply at the market open than willing demand at the prior day's close. Therefore, market prices are almost always at price levels where there is a supply and demand imbalance (opportunity) at the open.

Never forget, the successful market speculator simply finds a market where price is at levels where supply and demand are out of balance and trades them back to price levels where supply and demand is in relative balance.

I started in this business on the floor of the Chicago Mercantile Exchange, handling institution and retail order flow. Watching that order flow made it easy to see where prices were going to turn. For example, if we had 1000 to buy and 200 to sell at a price level, as soon as the first 200 were filled, price had to rise. Having the orders in your hand makes this easy to see, which is why it was illegal for me to trade my own account. Knowing exactly what this picture looks like on a price chart makes it even easier.

The Supply / Demand grid that you see below catches these opportunities as it focused on price levels with significant Supply / Demand imbalances. Over time, nothing changes as order flow works the same way it did 100 years ago and as it will 100 years from now. Second, novice traders are always present and are only growing in numbers. Here is how it all works...

Below we have a chart of the XLE (Energy Sector ETF). Notice the Supply level in the yellow box. We know this because price could not stay at that level; it had to fall because there was more supply than demand at that level. Next, notice how price gaps into the (supply) level at the market open. Here, the novice trader buys and the astute trader sells to that buyer.

Remember, a supply level is a price level where there is more willing supply than demand. The last thing you want to do is buy at that price level, but that is exactly what the novice trader did that morning on the market open. We want to focus on selling to that buyer, this is what we teach in class and focus on with our trading and investing tools and services. We know this is a novice buyer because only a novice trader would buy a gap up after a rally in price and into an objective supply level.

Supply/Demand Grid 12/11/16 - XLE Supply Level

Proven strategy for trading the market open.

The key is to not look at candles on your screen as red and green pictures and patterns. You must understand what is happening behind the scenes. Whether you're trading Stocks, Futures, Options or Forex, the logic and rules never change.

Again, the market imbalances are typically greatest at or near the open of trading in all markets. By the end of the first hour of trading each day, a large amount of novice trading capital is simply transferred into the accounts of the astute trader. If you can't see the novice trader in markets, be careful, the novice trader is likely you.

Hope this was helpful, have a good day.

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