Traders awoke to one of the best presents ever, thanks to positive Pfizer news on the coronavirus vaccine. It’s not every day you see Russell 2000 futures go limit up in overnight trading. IWM opened 8% higher this morning as companies that have been bogged down by the virus leaped higher.
A dozen stocks on my watchlist are up over 20%, from cruise lines and casinos to restaurants and oil companies. The reopening trade is back, baby!
The rarity of monster gaps like this requires dedicating today’s post to some best practices for how to deal with massive overnight moves. Here goes.
Best Practices for Monster Overnight Gaps
To be clear, I’m not talking about a garden variety overnight price jump in the S&P 500 that’s less than 1%. Instead, we’re talking about those rare occasions (like today) where U.S. Indexes either screamed higher or plunged lower overnight and are opening 3%+ from the prior day’s close.
For today I’m obviously focusing on an up gap. Here’s how I would respond with the following positions.
Existing Bullish Positions
Well, thank the maker! A gift horse just arrived on your doorstep. Don’t look him in the mouth. Instead, follow your plan. If you have short-term trades on, I bet they galloped past your target this morning. Follow-up and harvest gains, pronto.
As you’ve just learned anew, monster gaps like this often start filling early in the day. Some stocks have fallen significantly from their opens, quickly stealing gains. Taking partial profits and/or tightening stops is never a bad idea following such a windfall.
Existing Bearish Trades
Let’s not mince words. This morning’s was a nasty, no good trick for any poor souls in bearish trades. How do you exit at your planned stop point when prices soar past it in after hours trading? Answer: you don’t. And, on a side note, this is why you should only risk a small percentage of your portfolio in any single trade.
I have multiple suggestions for handling bear trades when you know the stock is opening well above your preplanned exit.
First, CANCEL ALL STOP LOSSES. Yes, that’s right. Cancel them, before the market opens. That includes buy stop orders for stock trades and any options positions with conditions that are going to route market orders at the open. I’m thinking primarily about bear call spreads that are gapping past the short call strike. The reason for canceling the order is twofold.
One: A gap of this size often sells off at the open when the “sell the news” crowd swarms. When that occurs, your loss on bear trades will lessen as the day wears on. But it won’t if you bailed at the open! So cancel the stop and let the market breathe for 15 to 30 minutes after the bell. If we keep ripping higher, then you can go ahead and exit. But I bet most of the time the market will be near the high of the day at the open.
Two: Liquidity sucks at the open following a large gap. Bid-ask spreads widen and that means market orders can get terrible fills. Even if you wanted to exit your trades quickly, I’d still cancel the existing stop losses and build out a limit order after the open.
What About New Trades?
I reviewed the Options report bull list this morning and virtually every setup was ruined by the up gap. Ironically, the bear list fared way better, with TWTR, GILD, SFM, CTXS, and DKS all triggering and/or still in play.
Gaps like this always throw a wrench into patterns. So you either go intraday and day trade or steer clear of new plays until a better setup emerges.
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