There are several variations of the opening range breakout, and one of the most common is the opening gap reversal.  Like any open range breakout, this online day trading pattern consists of a breakout from a range that has been set up in the first hours of trading.

There are two variations of the opening gap reversal; the first is a gap followed by a failed attempt to close the gap resulting in the reversal and breakout.  The second consists of a gap, followed by a failed attempt to continue in the direction of the gap which results in the reversal and consequent breakout.

The first variation is essentially the failure of the common perception that all gaps close.  Many people play opening gaps due to their volatility and added volume.  It is the common belief that gaps close more often than not, though I think this claim is dubious, and I have never noticed a huge bias of closing gaps to support that claim.  Though, because this is the belief, a lot of people enter trades hoping the gap closes.  As the price gets deeper and deeper into the gap, more tension builds.  You see, there was a reason why the stock gapped up or down, and that strength or weakness is often continued into typical trading hours despite the belief of those who think the gap should close.  Sometimes this tension and strength/weakness is enough to pull the stock away from the direction of the close, back to the opening price, and this is where things really erupt.  Due to the fact that so many have bet on that gap closing, if that opening price fails, a lot of stocks start exchanging hands as people realize their assumptions were incorrect.  This volume will shoot the price in the direction of the gap, either in a breakout or breakdown, and you can generally expect it to move at least the height of the gap before things stabilize.  The target for this one will be the equivalent of the height of the gap beyond the opening price.  For example, if the gap was 1 point, and the price reverses for a breakout, you should expect the price to rise at least 1 point above the opening price.

The second variation is due to the continued strength or weakness of a stock continuing for a few moments into the trading day. Sometimes a stock pulls a reversal like this if some news comes out in the morning that causes a jump in the price, but people realize how inconsequential the news actually is during the first few moments of trading.  This causes the initial run followed by the inevitable breakdown of that momentum as the price corrects itself to the previous day’s close.  This is the cause of many traders jumping on the bandwagon of momentum, and then bailing when their trading idea has been proven wrong.  The “proof” that their trading idea is invalid occurs as the stock crosses that day’s opening price.  When they realize they were wrong, volume increases, and the breakout or breakdown is on.  The momentum bandwagon will typically carry the price to the previous day’s open- this is your first target.  This is the only situation where the gap closes more frequently than not, making it a great day trading pattern.

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I figured since I am the (self-proclaimed) Chart Shark, I should probably give some basic idea of how to read stock charts.  I wrote a post a while ago that was pretty much a joke regarding the subject, but sometimes I forget that people are looking for real information.

3 Types of Stock Charts

Reading stock charts is actually quite simple.  There are 3 main types of online stock charts that you’ll find.  Lines charts, bar charts, and candlestick charts.  The first I want to cover is the line chart.  This chart is almost completely useless as a day trading chart.  If you watch it during the trading day, it just sits there and wiggles about and doesn’t give much real information.  Even using it to analyze stocks on a day-to-day basis is pretty useless because it doesn’t give you any idea about what happened during that day.  If you’re online day trading, stay away from line charts.

OHLC Charts, or bar charts are the next on the list.  These charts are better than line charts because they give you a better visual idea of what’s happening in the market in real time.  They are also easier to read than a line chart because, as the name implies, they give you the opening, high, low, and closing price on each bar.  Each bar represents a time-frame of your choosing from months, to minutes.  They aren’t the easiest to read quickly though, especially if you’re looking at a black and white bar chart.  This requires a sharp eye to pay attention where those tails are in order to identify strengths and weaknesses in a trend, which is why the OHLC chart is inferior to the next chart on our list.

Japanese Candlestick Chart

The final, and best type of chart for intraday trading is the japenese candlestick chart.  I find this to be the easiest chart to read, and analyze.  Even single color candlestick charts can be easily read.  This is because they use a “full” and “empty” candle stick to designate a decrease or increase in price.  ”Full” or black candles indicate a decrease in price while “empty” or white candles represent an increase in price.  The main parts of the candlestick are the body, and the wicks.  The wicks indicate highs and lows in the price, while the top and bottom of the body indicate opening and closing price for the time-frame selected.  If a candle consists of only wick with no body, this is called a doji.  A doji occurs when the opening and closing price are the same or very close.  They look like either a cross, and upside down cross or a plus sign, depending on the length of the wicks.

The candlesticks in a chart are lined up in series to give you a picture of intraday trading activities.  Below is a free stock chart courtesy of BigCharts.com.  In this chart below you can see that green candlesticks indicate an increase in price, while the red indicate a decrease.

The time frame for the chart is 5 minutes, which is the most useful for trading after 11am.  Before 11am I prefer to use a 1 minute chart, though I will glance at the 5 minute chart to get an idea of the greater trend.  Beyond that, before the market opens, I will also analyze the greater trends, and support/resistance of hourly and daily charts.

As you can see in the chart, the price ranged 2 points or 2 dollars for the day.  There were probably several opportunities to make money on this stock.  The interesting thing is that the days opening and closing price are only about .25 points apart, so the stock has hardly moved from one day to the next.  There was certainly a possibility of making much more than that if you were watching this intraday chart.

The next piece of basic chart reading is the ability to identify trends.  I have indicated some major trends on the chart above.  The first trend on the left is a pretty vague trend.  Ideally you want something more like the second or third trend where the candles touch the trend several times without breaking it.  Some people will trade these breaks in trends.  It’s not something I trade off of, but I will use trends as strength indicators, and I employ stock chart analysis to spot trading opportunities within the trend.

One final note in this basic article about how to read stock charts is that for online day trading, you’re obviously going to need stock charting software that displays real time stock charts.  This is absolutely necessary for intraday trading because you need to see the chart form and the trades happen as they happen.  You don’t want delayed information, because by the time you get that information the stock chart pattern you thought you saw might be 15 minutes old.

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What do you do once you’ve entered a trade? Do you already know where you’ll exit, be it a win or a loss, or do you just meander along until you feel like exiting? Or, even worse, do you sit there and agonize over every single move in your stock; exiting too early or too late and losing loads of money along the way?

Micromanaging Your Trades

You’re bleeding cash.  You watch every twitch and wiggle of the price and each move causes you a little more anxiety.  You rationalize exiting early or a little too late and each time you either lose money flat-out or you don’t profit where you should have.  You’ve spent countless hours developing your trading and still you don’t trust yourself.

Anne-Marie (of AnneMarieTrades.com) recently addressed this issue in her article “No One Likes a Micromanager Trader.” In her article she pinpoints the root of this issue:

Why do we micromanage our trades? The answer is simple: Fear and greed… It is reactionary behavior based on the impulsive fear of loss [or] potential for gain.

This is absolutely true.  On a primal level we love our money.  We want to protect it when we can, and we want to grab handfuls of it when the opportunity presents itself.  The problem with primal thought is that it gives little regard for the long-term.  It wants results NOW.  It doesn’t care if we’ve spent hours of our lives honing our trading skills.  It doesn’t care that a bad day, week or month does not mean we can not provide for ourselves or our families.  It doesn’t understand that we will prevail in the long-run.

Ways to Overcome Primal Thinking

Anne-Marie provides a few solutions to this problem in her article:

How in the world do we break a cycle of reactions based on fear and greed?…We achieve this with training. You can work on training yourself, find a mentor who might take you on, or you could hire a coach. Training creates discipline, discipline creates routine, and routine creates habit.

Again, this is true.  We can break this cycle with training.  I presume by “mentor” she means someone that will do this for free.  The likelyhood of finding someone who will do this for free is slim-to-none.  Unless you are related to this mentor, people who have broken these habits have better things to do when the market is open than break your bad habits.  They are probably out on a yacht somewhere drinking expensive scotch and making fistfuls of cash.

As for hiring a coach; these people come at a pretty hefty price.  If you are looking to pay someone  $1000/day to cuff you in the back of the head every time you do something stupid, my email address is on my “About” page.  I have some spare time and I’m always up for smacking the shit out of someone for being an idiot.  The first slap will come knuckle-first in reaction to you having hired someone to tell you what you’re doing wrong.  You know what you’re doing wrong.  You can overcome this on your own.

Using Advanced Orders for Trade Management

One of the tactics I’ve used to overcome this primal thinking is the use of advanced order types.  One of these advanced orders that I find addresses this issue is called the OT/OCA, or more commonly, a bracket order.  This combines the following two conditional orders:

• OTT (One Triggers Two) – When the first order is filled, two more orders are entered.  These two new orders both act as OCA orders for each other.
• OCA (One Cancels Another) – When one order is filled, the other order is canceled.

This allows you to enter the trade manually, and then your carefully crafted plan executes automatically.  I like this approach because I don’t do purely systematic technical trading.  I prefer to watch my stock’s chart and tape, and enter using my own discretion.  From there, though, my plan is set and I’ve found it easier to let it roll without second guessing myself.

As I said above, you’ve put a lot of time and effort into creating a trading strategy that works for you.  So let that system do exactly that – work for you.  When you start second-guessing your strategy you are working against it.  Utilize advanced order types and trade management to get the most out of your trading without completely handing the reigns over to a computer.

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You seem to think chart analysis is a lot more difficult than it really is.  Instead of giving it a go on your own, you rely on the wisdom of us brilliant chartists to hand you money-making set-ups on your favorite stocks.

I am here to tell you, friend, that it’s not that difficult to do some basic technical analysis on your own.  Let’s take a walk through the basics, shall we?

Connect the Pointy Bits

On a stock chart, you have peaks and troughs.  In order to identify the trend of a stock, you simply find these peaks and troughs and connect them with a line.  In order to make the chart fit your thesis, it is acceptable to plot the trend slightly below, or above the actual lows or highs.  Whatever looks prettiest works best.

Color Within The Lines

Though you may take some liberty with the actual placement of the trend line, don’t go overboard.  Stay on one side of the candlesticks.  I realize it’s difficult to grasp at first because there are just so many pointy bits, but you will get it with some practice.  I promise.

Adjust Accordingly

If you have publicly posited a thesis involving a current trend, and that trend is soon broken, you may feel slightly embarrassed.  This is a rookie mistake.  The pros know you can simply change the trend to fit the chart as it develops.  Then you simply say that the trend has shifted.  Place all blame on the stock or the market in general.  The truth is, we’re all pretty much making this shit up as we go along.

Learn the Simple Chart Patterns

With a clever combination of a stock chart and your trend lines, you can even draw some really cool shapes.  Above, you will see everything from simple geometric shapes, to male genitalia.  These patterns are presumably to help us chartists trade better, but really we just think they look super awesome.

There you have it; Charting 101.  It’s really not as hard as it looks. I have done the illustrations in the style of a 4 year old, because a 4 year old can do this.  Go ahead, and give it a try.  If you want a more serious walk through on some charting basics, check out how to read stock charts.

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The Opening Range Breakout is one of the simplest day trading set-ups to understand.  The first hour of the trading day is the most volatile.  Bears and bulls are battling it out in the stock market, trying to show you who’s going to be the boss for the day.  This volatility creates a price-range you can trade from.  Like all breakout trading set-ups, this is a great set-up because it offers a very low risk entry.  If there is no follow-through on the opening range breakout, you should exit the trade immediately.

The Time-Frame

You are looking for opening range breakouts to occur between 9:50 am and 11:00 am.  This gives a stock enough time to develop the range while giving you enough information to determine which direction it will breakout.  The chart above is the chart for Apple (AAPL) from Friday, September 4th, 2009. In this example, the range developed between 9:30 & 9:45 and the opening range breakout occurred at 10:35.

Factors for Breakout Success

There are 3 factors that need to be considered in order for the opening range breakout trade to be probable and profitable.

1. The price has to show a bias towards one side or the other.  You can see in the stock chart above that the price started low, made a high at 168.60, pulled back but then began trending towards the high.  The uptrend signifies a strong bias towards the high and increases the probability of a follow-through if the high is broken.
2. The high or low needs to be tested.  In the Apple (AAPL) chart, the high was tested shortly before the breakout.  Without this test, this level hasn’t proven to be resistance or support so a follow-through is less likely to occur.
3. Volume should be high.  Something to keep in mind with any breakout trading play is that the volume should increase on the breakout.  The trades on the tape should be increasing in size and quantity as the level is broken.  This ensures that the trade has the momentum to continue on to your targets without falling back into the opening range.

These 3 factors will ensure that you get the maximum probability of a follow-through on the Opening Range Breakout.

Exit Strategy

Checking out the 5 minute chart, you can see that this would have been a successful opening range breakout trade.  To exit, I like to scale out.  It is no secret that I love whole numbers as natural support/resistance which makes them great targets.  169 is a great target to lock in some quick profit.  170 makes another great target for 2 reasons.

1. It’s the next whole number.  Whole numbers are important psychological levels.
2. It provided significant resistance on September 1st, just a few days before this breakout.

There it is; the opening range breakout.  If you have any questions or comments, just leave them below.

PR: wait… I: wait… L: wait… LD: wait… I: wait… wait… Rank: wait… Traffic: wait… Price: wait… C: wait…

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