Profitable ETF Gap Trading Strategies

Last Updated on January 26, 2023 by Mark Ursell

I tested three different ETFs to answer the question:

Can you profitably trade opening gaps? And if so: what markets and factors increase your chances of big winning trades?

To trade well you need to get the odds in your favor. Whether you are a day trader or swing trader this analysis will help you make better trading decisions.

A lot of the results were a confirmation of what I expected. But there were quite a few genuine surprises too.

Video Of Me Demonstrating

You can see even more detail in the video below. Watch me showing the different options, and showing you how I did the analysis.

Some Key Findings

1. All Gaps are not equal – I found that the most profitable Gap Up trades occurred after the gap has closed. Whereas Gap Down it did not matter if the gap closed or not.
2. Different markets need a different approach. There was a huge difference between trading the XLF and QQQ. QQQ gives good trades when the market Gaps Up AND Gaps Down. XLF gives much better trades when the market has gapped up.
3. Different preceding conditions can increase your odds of a big winning trade. In many scenarios, you can increase the size of the average winning trade by waiting for a downturn in the market. I measured this by a count of the number of consecutive down days.
4. Longer holding time usually means bigger winning trades. However, you need to pick your trades carefully to make sure you hold onto the trades with the best potential.
5. Longer holding times also often means a higher percentage of winning trades. In most cases, you can increase your odds of a winning trade by staying in the trade for a few days longer.

How I Tested

The test was carried out using a Tradinformed Backest Model.

The backtest models are built using Excel and you can use them to develop new strategies and improve your trading.

What Did I Test?

All the backtests tested long trades.

All the tests took trades using either a limit or stop order. The entry conditions were checked at the close of the day after the gap. The order was set for the following day.

The backtest looked at Gaps Up and Gaps Down.

The backtest looked at different holding periods to see if that increased the size of the winning trades.

XLF – Financial Select Sector

Key Takeaways

• The XLF ETF performed much better when the market gapped higher.
• Limit orders were more successful than stop orders.

XLF – Full Results

[table caption=”” width=”750″ colwidth=”175|125|125″ colalign=”left|center”] Gap Type,Gap Up,Gap Down,Gap Down,Gap Up,Gap Up,Gap Down
Order Type,Limit Order,Limit Order,Stop Order,Stop Order,Stop Order,Stop Order
Holding Period,1 day,1 day,1 day,1 day,5 days,5 day
Gross Winning Trades,” $115,360 “,” $95,071 “,” $132,059 “,” $80,184 “,” $171,422 “,” $197,630 “
Gross Losing Trades,” $-70,644 “,” $-99,736 “,” $-123,850 “,” $-74,623 “,” $-128,370 “,” $-162,253 “
Net Profit,” $44,715 “,” $-4,665 “,” $8,209 “,” $5,561 “,” $43,051 “,” $35,377 “
Profit Factor,1.63,0.95,1.07,1.07,1.34,1.22
Winning Trades,117,142,180,113,95,125
Losing Trades,72,129,159,90,62,90
Percentage Winning Trades,61.9%,52.4%,53.1%,55.7%,60.5%,58.1%
Average Winning Trade,986,670,734,710,”1,804″,”1,581″
Average Losing Trade,-981,-773,-779,-829,”-2,070″,”-1,803″
Largest Winning Trade,” $4,407 “,” $3,255 “,” $4,461 “,” $3,072 “,” $7,542 “,” $7,027 “
Largest Losing Trade,” $-4,336 “,” $-4,342 “,” $-5,088 “,” $-3,670 “,” $-7,863 “,” $-7,550 “
Date Range (years),9.47,9.47,946.8%,946.8%,9.47,946.8%
CAGR,4.0%,-0.5%,0.8%,0.6%,3.9%,3.3%
Max Drawdown,9.3%,10.4%,11.3%,8.3%,18.4%,20.4%
MAR Ratio (CAGR/Max DD),42.7%,-4.8%,7.4%,6.9%,20.9%,15.9%
Average trade expectancy (%),0.30%,0%,0%,0%,0.45%,0%
Expectancy per bar,0.30%,-0.01%,0.03%,0.06%,0.09%,0.05%
[/table]

QQQ – Nasdaq 100 Tracker

Key Takeaways

• The QQQ performed well in most scenarios with stop and limit orders.
• You can increase the size of winning QQQ trades by holding onto the trades for longer.

QQQ – Full Results

[table caption=”” width=”750″ colwidth=”175|125|125″ colalign=”left|center”] Gap Type,Gap Up,Gap Down,Gap Down,Gap Up,Gap Up,Gap Down
Order Type,Limit Order,Limit Order,Stop Order,Stop Order,Stop Order,Stop Order
Holding Period,1 day,1 day,1 day,1 day,5 days,5 day
Gross Winning Trades,” $199,358 “,” $113,714 “,” $144,111 “,” $180,768 “,” $109,851 “,” $285,500 “
Gross Losing Trades,” $-126,884 “,” $-71,219 “,” $-118,329 “,” $-134,581 “,” $-83,300 “,” $-171,355 “
Net Profit,” $72,474 “,” $42,495 “,” $25,782 “,” $46,187 “,” $26,552 “,” $114,145 “
Profit Factor,1.57,1.60,1.22,1.34,1.32,1.67
Winning Trades,102,125,164,199,140,144
Losing Trades,67,86,115,154,98,78
Percentage Winning Trades,60.4%,59.2%,58.8%,56.4%,58.8%,64.9%
Average Winning Trade,”1,954″,910,879,908,785,”1,983″
Average Losing Trade,”-1,894″,-828,”-1,029″,-874,-850,”-2,197″
Largest Winning Trade,” $6,580 “,” $2,583 “,” $4,623 “,” $4,968 “,” $3,137 “,” $7,748 “
Largest Losing Trade,” $-6,430 “,” $-3,234 “,” $-6,002 “,” $-3,660 “,” $-3,459 “,” $-9,234 “
Date Range (years),9.47,9.47,9.47,946.8%,946.8%,946.8%
CAGR,5.9%,3.8%,2.5%,4.1%,2.5%,8.4%
Max Drawdown,17.4%,7.1%,11.2%,11.5%,12.7%,10.9%
MAR Ratio (CAGR/Max DD),34.2%,53.4%,21.9%,35.7%,19.8%,77.0%
Average trade expectancy (%),0.39%,0.18%,0.105%,0.145%,0.134%,0.553%
Expectancy per bar,0.08%,0.18%,0.10%,0.14%,0.13%,0.11%

[/table]

SPY – S&P 500 Tracker

Key Takeaways

• The SPY performed fairly well in most scenarios.
• You can dramatically increase the size of average winning trades by holding the trade for longer.

SPY – Full Results

[table caption=”” width=”750″ colwidth=”175|125|125″ colalign=”left|center”] Gap Type,Gap Up,Gap Down,Gap Down,Gap Up,Gap Up,Gap Down
Order Type,Limit Order,Limit Order,Stop Order,Stop Order,Stop Order,Stop Order
Holding Period,1 day,1 day,1 day,1 day,5 days,5 day
Gross Winning Trades,” $196,264 “,” $99,042 “,” $151,830 “,” $199,263 “,” $98,037 “,” $341,820 “
Gross Losing Trades,” $-138,399 “,” $-70,516 “,” $-133,510 “,” $-154,152 “,” $-88,795 “,” $-192,888 “
Net Profit,” $57,865 “,” $28,525 “,” $18,320 “,” $45,111 “,” $9,242 “,” $148,932 “
Profit Factor,1.42,1.40,1.14,1.29,1.10,1.77
Winning Trades,95,103,170,218,119,162
Losing Trades,66,76,134,175,96,78
Percentage Winning Trades,59.0%,57.5%,55.9%,55.5%,55.3%,67.5%
Average Winning Trade,”2,066″,962,893,914,824,”2,110″
Average Losing Trade,”-2,097″,-928,-996,-881,-925,”-2,473″
Largest Winning Trade,” $7,517 “,” $2,430 “,” $4,103 “,” $6,138 “,” $2,532 “,” $8,027 “
Largest Losing Trade,” $-8,658 “,” $-3,755 “,” $-7,091 “,” $-3,546 “,” $-3,770 “,” $-12,689 “
Date Range (years),9.47,9.47,946.8%,946.8%,946.8%,946.8%
CAGR,4.9%,2.7%,1.8%,4.0%,0.9%,10.1%
Max Drawdown,13.1%,4.8%,17.5%,11.9%,8.6%,8.4%
MAR Ratio (CAGR/Max DD),37.8%,55.4%,10.2%,33.8%,11.0%,119.8%
Average trade expectancy (%),0.25%,0.15%,0.06%,0.11%,0.05%,0.51%
Expectancy per bar,0.05%,0.15%,0.06%,0.11%,0.05%,0.10%

[/table]