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Gravy in the Gap

By Frank Ochoa, MrTopStep

Traders will often use the phrase "gravy in the gap" when the market is a runaway train during overnight and premarket trading, only to trade in an otherwise small price range during the actual floor session after the open. Here's a simple technique that I use for forecasting accurate price targets (over 90%!) when this occurs.

Monday's ADR targets

I'm a fan of using average daily range (ADR) for forecasting targets. However, if you're trading using an RTH chart (excluding overnight session data), then there are times when the market will gap past your key ADR targets due to a large overnight rally or selloff - as was the case Monday. Take a look at the ETH chart of the E-mini S&P 500 futures (ESH14:CME), which includes data from Sunday evening and Monday morning. The 1754 overnight low printed during the 9pm CT hour Sunday evening. Using this low and the current 10-day ADR of 15.25, we can then forecast our typical ADR upside targets at 1765.50 (75%), 1769.25 (100%) and 1773 (125%), which were all hit before the 8:30am CT open.  However, once the ES (^GSPC:SNP) opened the session at 1777.50, these ADR targets become useless, as they've already been reached, which can be frustrating had you not traded the premarket action. And this is where the Gap-Adjusted method comes into play.

Gap-adjusted ADR targets

Gap-adjusted targets are extremely easy to calculate. All you have to do is take half of the day's ADR and forecast it higher and lower from the session's opening print on days when price gaps beyond your primary targets (namely the 75% and 100% projections). Using Monday's market as an example, the ES opened the session with a gap up to 1777.50, surpassing the primary and secondary targets, and even the extended target of 1773. In this case, taking half of the 15.25 10-day ADR and projecting this value higher and lower from the 1777.50 open gives us a bull target at 1785.13 and a bear target at 1769.88. ES RTH
My research on this approach shows one of these targets is hit at some point during the day 90% of the time. Since the bulls came roaring back off the 1754 lows, the clear choice for the target to shoot for was 1785.13. In this case, the gap-adjusted bull target came within one point of forecasting the high of the session, which was 1786.25. If a trend day develops and price blows through your primary gap-adjusted target, just forecast 25% increments of the 10-day ADR in the direction of the primary move. As I often say, trading ain't easy, but it doesn't have to be difficult.

As always, use stops and keep an eye on the 10-handle rule. Don't forget to catch MrTopStep on The Closing Print video. We report directly from the SPX pits, wrapping up the day and positioning for trade tomorrow.

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MrTopStep can be followed on Twitter at twitter.com/MrTopStep

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