Here is a simple intraday gap trading setup purely based on Gap Up & Price Action technique. The chart timeframe for this intraday gap strategy is 5 minutes.
Interestingly, you can use this setup to trade stocks, equity indices, commodities, or even currencies. Further, you can use any instrument to trade it i.e. cash (equity shares), futures, or options. Also, with this strategy, you can trade in a bullish as well as a bearish market.
We will trade stocks that have gapped up and look for a couple of price action confirmations to confirm the trade setup. Hence this strategy is going to be a combination of both Gap Up and Price Action.
Let’s understand the process step by step as to how we analyze and trade this strategy. It’s an Intraday short strategy. You will sell first and buy later to square off your position. The act of selling first and then buying back the shares to square off the position is called short sell.
Steps of the setup:
We’re analysing the Bank Nifty spot chart in the example below.
Step 1 : Here, we will look for an open gap in the first 5 mins candle of the day.
What is an open gap? As the name suggests, there should be a gap between the high and low of two separate candles. We should look at the open gap in the first 5 minute candle of the day. Remember, here we are talking about the candle which is formed in the first 5 mins of the day and not the 5 mins candle which gets formed later. Let’s understand this through an example. . We will look at a price chart on Upstox pro web platform.
Here, we can see an open gap in the first 5 mins candle of the day. Look at point A (high of the previous day’s last 5 mins red candle) and point B (low of the next day’s first 5 mins red candle) This is what is referred to as an open gap.
Step 2 : The first 5 mins candle (candle with an open gap) should give a bearish signal (red close)
After an open gap, the first 5 mins candle should close in red. We don’t have to look for any bearish candlestick pattern. Just a red close is enough. If the first 5 mins candle closes in green then the setup is invalid.
We can see the first 5 mins candle has gapped up and closed in red (red candle marked with an arrow)
Step 3 : The second 5 mins candle should also give a bearish signal (red close)
After an open gap, the first 5 mins candle should close in red. The second 5 mins candle after the open gap candle should also give a red close. Again, we don’t have to look for any bearish candlestick pattern. Just a red close is enough. If the first 5 mins candle closes in red and the second candle closes in green then the setup is invalid. Both the first and the second 5 mins candle should close in red.
In the chart above, We can see the second 5 mins candle has also closed in red(arrow marked )
Step 4 : Let's understand this with the help of a chart and decide what price we enter, where we keep our stop loss and when to exit the trade (target).
You can see the GREEN line (36034) that's where we got the confirmation of the open gap and the first two 5 mins candles closed in red by giving a lower close. Moment the low of the second red candle is broken, our entry is triggered. We will enter around those levels at 36034. Since Bank Nifty spot can’t be traded, you can look to trade Bank Nifty futures or options. If you choose to trade options, one way to go about it is that you can buy an ATM (at the money) strike price put option to trade. In our example, the market price is 36034and the nearest strike price is 36000 put option. Since it’s an intraday trade, you can go for a weekly expiry rather than a monthly expiry contract.
Now, let us consider stop loss. You can see the RED line (36223) which is the high of the first 5 mins candle. That's 189 points above the entry point of 36034. If the Bank Nifty goes and hits 36223 (our stop loss), we will take a loss and exit our position.
Since it’s an intraday trade, the timeframe of the chart is 5 minutes, we will aim for a risk to reward of 1:2. In our example the risk being 189 points, we will aim for a target of 378 points from our entry price which comes to 35636 (36034-378 )
You can see the PURPLE line (35636). Once the price hits 35636, we will exit our 36000 put option position.
We hope this intraday gap strategy was simple and easy to understand. You can try spotting it on charts and see if you are able to identify such setups.
Until then, happy trading!