Trading Gaps Dummy Style - Part I

I've been getting a lot of email and comments concerning my dummy style gap trades lately, so I thought it might be useful to write a post and answer all of the queries at once.

My objective in gap trading is to profit from high volume (momentum) after the stock consolidates the opening gap. The consolidation usually presents a low risk entry opportunity ie. dummy entry point. For the purposes of this post, I am excluding gap fade and gap fills. In other words, I'm concentrating on long gap ups and short gap downs.

Sources I use for identifying potential gapper candidates:

1.Pre-market top trade counts from my IB (Interactive Brokers) platform;
2.Esignal;
3.Briefing.com gapping up and gapping down lists found in the Live -In Play section or posted daily over at Trader Mike's blog in the morning Watchlist post.
4.Quote.com - Unfilled Gaps
5.Trade-Ideas gapper scans;
6.Stockcharts.com Realtime Extra - User defined scans.

For more sources check out Trader-X's list.

I've received a lot of questions regarding stockcharts.com as a scanning tool. Again, I just want to point out that Trade-Ideas is my preferred scanning tool, however, due to limitations of the workplace, I use stockcharts.com because it is available on any computer through the internet and requires no downloads.

Scans

I run two scans as follows:
Gap up - Average daily volume > 300k; Price > $10.00 and < $150.00; and today's open > yesterday's close.

Gap down - Same as the gap up for volume; Price > $20.00 and < $150.00; and today's open <> low.

For some reason, the gap down scan usually results in a much longer list than the gap up. I'm still looking for ways to filter out some of the noise and concentrate on the big volume movers.

The great thing I like in stockcharts.com is that I can download the scan results into two separate folders and quickly run through all of the charts on both the daily and 15 minute timeframes.

Identifying Good Candidates

The criteria I use for spotting high probability gapper setups for long entries are:

From the daily timeframe:

Ideally, the gap up has broken out of a consolidation pattern or a base on the daily timeframe. I avoid stocks that are moving up towards a downsloping 50 MA if the MA is too close as it will act as resistance and could force an early exit. Flat MAs are less of a problem especially if the stock has been in a bullish base for a long period of time. The daily view is a good place to identify price targets from resistance areas. If the stock is hitting 52 week highs, I go back to the weekly or monthly timeframe.

From the 15 minute timeframe I look for:

High volume relative to recent volume levels.
Candlestick patterns - Wider bullish sticks on the open followed by a tight consolidation in the upper part of the opening range or, an orderly pullback towards the rising 10 period EMA. I define an orderly pullback as small sticks with little or no overlap of the real bodies on declining volume.

The other pattern to look for is the shallow rounded base consolidation pattern that Tom C. and Trader-X refer to as the "U". The shallow base is a very bullish setup on its own, but combined with a gap up, it can be particularly powerful.

Things I try to avoid:
Extremely wide opening ranges and low volume.
Choppy price action and bar by bar shakeouts.

In Part II (later this week), I will discuss my entry and exit techniques.