If you keep up with my tutorials, then you know I like simple trading methods like the opening range breakout strategy.
I tend to focus on simple strategies because I often see many beginner traders who believe complex systems equate to bigger gains…
But that’s just not the case.
More often than not, complex strategies don’t equate to accuracy or success as is often believed to be the case.
For example, I know a few traders who use the Gann Lines and Elliott Wave theories… But never for more than a few months at most.
I’ve also never seen a professional fund manager use these methods effectively in the past.
The Opening Range Breakout Strategy Has Withstood the Test of Time
This is what led me to write about the opening range breakout strategy.
This simple technique has been around for more than 50 years and is still one of the most popular entry strategies to this day.
As a matter of fact, I know several pro traders and fund managers who use it as their primary entry method.
The opening range is the highest and lowest price traded during the first half hour of the trading day.
You’ll often hear me refer to the first half hour trading range as the “opening price bracket.”
This period is important because it sets the tone for the remainder of the trading day… And because several market-moving events can occur between the closing of the previous and opening of the current session.
These events are things like government reports, stock earnings and overseas markets news… There are dozens of fundamental and technical factors that play a vital role in the U.S. economy and, more relevantly, on market sentiment…
And like I said before, they can have a major impact on the upcoming trading session…
The Roger Scott videos I post on WealthPress.com each morning provide daily schedules of market-moving news that will be released in the upcoming hours, days and weeks. So make sure you check those out each morning!
The Opening Range Breakout Strategy: There Is Strong Buildup From Overnight Markets
During the first half hour of the trading day, which happens to be the most emotional part of the session, markets tend to absorb the overnight information and reflect it in their price.
Even though most markets are open virtually around the clock, the majority of volume and volatility doesn’t appear during the overnight session. It begins after the stock market opens each day at 9:30 a.m. EDT.
This is when institutional traders come into the market to buy and sell enormous quantities of shares through a computerized trade execution system called program buying and selling.
The volume is so enormous that it can have a strong impact on the short-term movement of the stock market.
These institutional buy and sell programs don’t get executed during the overnight session, so it’s difficult to see what impact the overnight action will have on the market until the regular day session begins.
There have been numerous times when the overnight market is pointing in one direction with a strong bias, only to open and move in the opposite direction within the first half hour of the trading session.
Overnight markets do offer strong clues to the direction the market is headed but, ultimately, there’s no better indicator of direction than the market itself after the first half hour of the trading session.
The Opening Range Breakout Strategy: Conditions Must Be Met Before Execution
When trading the opening range breakout strategy, I prefer to use a five-minute bar chart and place a buy stop a few ticks above the highest price reached during the previous six bars. At the same time, I also place a sell stop a few ticks below the lowest price reached during the past six trading bars.
But I also need to make sure three additional conditions are met before I enter the market in either direction…
Avoid Trading Late In the Day
The first condition to market entry is time.
The market must hit the buy stop or sell stop within one hour of defining the high and low of the opening range bracket, or 1 ½ hours after the opening bell.
After years of observation and computer backtesting in several different markets, I’ve noticed that the quicker the market breaks above or below the opening range bracket, the better the odds are of the trade working out.
Most breakouts that occur later in the day don’t carry sufficient momentum to sustain the volatility and direction that makes it worth the risk of entering the trade after the first hour and a half of the trading day.
Bias Toward One Side
The second condition prior to placing my entry order I like to see is continuous bias toward one particular direction.
I often see markets swing back and forth between the high and low of the opening range. When I see this type of market action, I avoid entering a position even though all other conditions have been met.
The ideal market action prior to breaking out of the opening range occurs when the market tests either the high or the low on more than one occasion, or trades close to that level repeatedly.
I want the stock to make higher highs and higher lows in anticipation of breaking out to the upside, or making lower lows and lower highs for the majority of the first half hour, leading to a breakdown to the downside.
What I don’t want to see when trading the opening range breakout strategy is a stock that keeps swinging back and forth in a choppy range between the high and low brackets.
Volume Drying up Isn’t Good
The third and final condition to entry is volume.
There must be a substantial and gradual build up or increase in volume leading up to the breakout or breakdown in price outside of the opening range price bracket.
The majority of the time, market volume peaks during the first 15 and the last 15 minutes of the trading day…
As a result, volume at the 30-minute mark typically begins to fall off, making it difficult to accurately gauge volume at the 30-minute mark… even when markets are making new highs or lows.
My solution to deal with volume drying up is simple…
As long as volume drops off gradually and is still within the range that existed during the first 15 minutes of trading, I don’t consider it a trade breaker.
But if I find that volume is barely moving compared to how it was during the first 15 minutes, I reconsider placing the order.
While monitoring volume isn’t an exact science, you will develop a good feel for how volume comes into the market, and how markets react to it with time.
Always remember that breakout entries are typically accompanied by an increase in volatility. So make sure your stop loss takes into account the added volatility and adjust your stop-loss levels accordingly.
And if you haven’t done so already, subscribe to our YouTube channel so you can be notified as soon as we make our next post, and see what trade opportunities we’re paying close attention to!
All the best,
Senior Strategist, WealthPress