Gap Strategy on Swing Trades

A Bandit subscriber recently asked me about dealing with gaps on swing trades. This was a great question, so I wanted to be sure to share this exchange with you in hopes of you adding your thoughts on this as well.

Background on the Situation:
This question came in reference to a swing trade I had listed Sunday night inside our member area.  MGA had fallen below an ascending triangle pattern the previous week and bounced back up to test the breakdown area only to stall out.  This appeared to be a potential short-term lower high (and failing bounce), so I listed it as a short sale heading into Monday’s session if it broke the rising trend line at $45.20 (see chart).

This was to be a swing trade, which is an overnight position – at least until target or stop levels had been hit.  My swing trading strategy allows for some gapping beyond my intended entries, but then I scale back my size the further a stock gaps.  This helps offset the added risk with a wider discrepancy between my actual entry and my initial stop loss.

In the case of MGA, it gapped 2.8%, warranting only a partial position of 1/4 size.  The gap was filled quickly, and I ultimately stopped out Tuesday as the bounce continued, taking a loss on this very small position.  Nonetheless, that’s the setting here under which this trader asks the following questions.

Question:
Jeff, most of the time when I set up my bracket orders for swing trades my initial trigger to open a position is a stop limit order.  I use the limit order portion when I am working during the day and cannot actively adjust for gaps, as this way I don’t by default enter the trade in less than ideal conditions.  In the case of MGA which had the immediate pullback, I was in moments after the opening.  So my question is in general trades like MGA that return back to the original trigger levels should I let the trade continue or would I be better off passing on the trade?
Thanks

Answer:
Great question.  I take it from your question you have mobile access or some way to get in and make an adjustment to the trade once you’re in.  Some brokers offer several levels of sophistication with regard to managing orders like this, but if you are not inclined to complicate things then I’d say on trades like this just pass on it.  The best trades for me tend to not come back to the trigger or go against me right off the bat.  That is more characteristic of the losing trades I make.

I’d say to keep things simple, if the stock gaps beyond a certain amount you specify, then just skip it, or next-best scenario would be to just close out the position as soon as you notice you were filled.  Either you got a price you didn’t like or you have more shares at that price than you want, but the point is you recognize it’s not the trade you had intended to take.  Closing these out may mean a small gain or loss, but I suspect those will wash out over time and overall you’re sticking with an overall gap strategy which is suitable for your unique needs.

How do you manage gaps on entries when you’re away from your screens?
What would you tell this trader?

Trade Like a Bandit!

Jeff White
Producer of The Bandit Broadcast

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