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Options Theory: How I Deal with Gaps that Steal My Entry

October 4, 2018

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Options Theory: How I Deal with Gaps that Steal My Entry

It’s the weekend. You’ve scoured the Options Report, found your favorite setups to trade for the next week. You’ve set your alerts or entry orders, Monday arrives and BAM! the market gaps higher right out of the gate robbing you of the ideal entry.

Like a pirate.

“Boo! C’mon Mr. Market. Why you gotta hate like that?”

I feel your pain and have noticed a few of the comments in the Clubhouse regarding these pesky gaps. DIA, BA, CAT, CMI, AXP, and NVDA were all perpetrators this week. So what’s the solution?

My semi-sarcastic answer is to enter on Friday, the day before it gaps. But then you’ll come back to me with the obvious remark that nobody can predict the day it’s going to gap. So I won’t say enter on Friday;)

Before I divulge how I would deal with this situation, let me say that every single entry technique or trick has tradeoffs and you won’t find one that doesn’t leave you high and dry from time to time. So I think it best not to stress about missing the occasional trade. Opportunities are like Uber drives in the city. There’s always another one around the corner.

The inescapable tradeoff for varying entry techniques is as follows:

Do you want more confirmation and a worse price or less confirmation and a better price?

I prefer the latter. Take the setup in CAT for example. Would you have entered a bull trade last Friday or would you have waited for Monday when it rallied above the prior day’s high?

I deployed my trade on Friday because one of my trigger techniques is to enter when the stock breaks above intraday resistance. And, well, CAT broke above intraday resistance and closed near the high of the day with a bullish hammer candle. This tactic often gets me in quicker than waiting for the daily chart to pop above the prior day’s high. The sacrifice I’m making, of course, is a higher risk of entering a trade prematurely.

I could argue that you could have entered BA and DIA on Friday as well. Honestly, I wouldn’t have minded entering AXP and CMI as well with anticipatory entries.

Here’s why I’m a little more relaxed about my entry points: because I scale-in. I have two or three chances of nailing the entry. Most new traders only have one. And because they buy all at once, they obsess about the entry, fretting about whether they are too early or too late. I prefer to enter on the day I think it’s turning – EVEN IF IT HASN’T NECESSARILY GONE ABOVE THE PRIOR DAY’S HIGH. The upside is I’m already in if it gaps higher the next day. The downside is I sometimes get tricked in early and have to then sit through some pain before the stock finally moves in the right direction.

And, here’s the most critical part, I’m okay with that trade-off. I’m comfortable with it and am willing to accept the ramifications of my technique.

Once you develop a full understanding of scaling and sound management techniques, your worries about perfect entry points will diminish. It’s still important to identify quality setups and the closer you are to the eventual turn in the stock the better. Nonetheless, entering with multiple tiers doubles or triples your chances of playing the pattern successfully.


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3 Replies to “Options Theory: How I Deal with Gaps that Steal My Entry”

  1. FERNANDORODRIGUEZ says:

    Great article Tyler. I was one of the “victims” of the market gap up this Monday.
    I missed a few ones, but was able to get later and I felt OK with my compromise between confirmation and price.
    And certainly, having more than one opportunity (scaling in) helpmed me a lot.

  2. KarlHoffmann says:

    Great article Tyler, i read this after my short trades on ABBV and BDX gapped outside of my entry!

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