Weekly Update: The ORB Strategy for Trading Gaps
Good evening, and welcome to this week’s edition of Stealth Trades!
Last week was a short one. As such, not much changed in the stock market.
So instead of wasting your time with a market update, I’d like to instead share a simple strategy for trading stocks that gap up in the morning.
A “gap up” is when a stock opens significantly higher than it closed the day before. This is typically due to earnings, drug trial results, or some other positive development with the company.
Here’s one that took place this morning – Wolfspeed (WOLF).
You are looking at a 5-minute chart. WOLF stock closed Thursday at $1.17 then gapped up to open today’s session 23% higher at $1.44.
Gaps are tough. Sometimes, a stock will gap up and just rip higher all day long. Other times, the gap is met with immediate selling, and most of the overnight gain evaporates.
There is almost no way of knowing which scenario you will see. But there is a way to protect yourself and ride the ones that shoot higher.
It is called the Opening Range Breakout strategy. And – just as the name implies – the goal is to buy the breakout of the opening range.
The first few minutes of trading will see heavy action. Momentum traders jumping in, current investors cashing out, and all sorts of rebalancing activity take place. After that, the stock picks a direction.
Depending on the size of the company, this opening range action will take somewhere in the neighborhood of 1 to 15 minutes. So, here’s what you do…
Set your chart to a shorter timeframe like 5 or 15-minute bars. I will be using 5 minutes in this example.
Once that first bar completes, draw a line at the top and bottom of the range. If the stock breaks out above the opening range, you buy. Then place a sell stop order at the bottom of the opening range.
This morning’s trade in Wolfspeed would look like this:
In this case, the opening range was a bit wider than I like at 10%.
But that risk would have been more than justified as the stock ran another 70% higher from your opening range breakout point (see below).
The goal of the trade is to get the most favorable risk/reward ratio possible. Oftentimes, that opening range is just 3 or 4%.
What I like to do is sell some of the position once I am up a multiple of my risk. In the case of WOLF, since the initial risk was 10%, I would have been selling a quarter or half of my position once it was up 20-30%. At that point, you can raise your stop to breakeven and let the trade work.
This setup will not always work. In fact, you will probably lose more than you win. But it is a way to sometimes get returns of 10X or 20X your risk.
Look at this entry on Tesla (TSLA) back in November…
After Trump won the election, Tesla shares gapped up 13% overnight.
The 5-minute opening range the next morning was less than 3%. Three percent is a small risk to potentially catch a big move on Tesla.
It did not hit the entry point until the end of the day.
But once it did… liftoff.
This was the beginning of a powerful 6-week move in Tesla that delivered up to a 66% gain. Heck, you would have been up over 20% in the first couple days… by risking a measly 3%.
This is not the end all be all. But it is another trick to have in your toolbox.
I use this a lot when I’m waiting for a stock to break out and it does so on an overnight gap. Instead of placing my stop loss way down at the previous swing low, I use the opening range breakout strategy to keep tight entry and exit parameters.
Give it a shot and let me know what you think.
Best wishes for your trading,
