Thursday, December 9, 2010
Large gaps higher have traded in a predictable pattern this year. Learn to trade them the right way and you can earn consistent profits day trading them.
If the overnight gains in the S&P futures market hold up into this morning, stocks are going to gap sharply higher. Here's how to day trade it…
Watch the action during the first hour and note where the S&P 500 is trading at the end of it. If the index ends the first hour near its highs, the odds favor continued strength throughout the day and a final push higher into the close. The best strategy here is to use any small two- or three-point pullbacks in the S&P 500 as opportunities to add exposure to S&P 500 exchange traded funds (ETFs).
On the other hand, if stocks don't end the first hour near the highs of the gap, the market usually gives up most of its gains by the end of the day. Your best trade here would be to sell short an S&P 500 index ETF or purchase one of the widely available inverse ETFs – which move in the opposite direction of the index.
Here's how it worked on Monday…
President Obama and the Republicans reached a deal to extend the Bush-era tax cuts for another two years, extend unemployment benefits, and temporarily reduce the payroll tax. The overnight futures market rallied on the news.
By the time Wall Street opened for business, the Dow Jones Industrial Average gapped up 90 points, and the S&P 500 gained 11 points and was trading at a new yearly high. At the end of the first hour, the gains had fallen back to 67 points for the Dow and six points for the S&P.
Since the market ended the first hour well below the early morning highs, it was a good bet the market would give up most of the rest of the gains by the day's end. Day traders could have purchased the ProShares UltraShort S&P 500 ETF (SDS) for $24.85 per share.
Sure enough, by the end of the day the market behaved predictably and gave up all of its gains. The Dow closed down three points and the S&P 500 was fractionally lower as well.
SDS, which trades inversely to the market, closed at $25.23. That's a gain of $0.38 per share, or roughly 1.5% – pretty good for a one-day trade that required only a little attention at the end of the first hour of trading, and a sell order at the end of the day.
Of course, day trading isn't for everyone. And not every trade works out successfully. But if you like the idea of making small gains on daily transactions a few times each week, look for predictable patterns like this one.
The gains can really add up.
Best regards and good trading,
"Every morning, I wake up, turn on my computer for a few minutes, pocket a little cash, and call it a day. Often times, my workday ends by 10:30 a.m.," Jeff writes. "By day trading stocks and options, you can make as much money in just a few minutes as many hardworking folks make in a whole day." Learn more about the basics of Jeff's day trading strategies here and here.
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