The basic premise of the opening range (OR) trading approach is that your bias for trading a stock is determined by where the stock is trading relative to the opening range. If the stock is trading above its opening range you should have a bullish, and if the stock is below the opening range you should have a bearish bias. Until the stock is trading outside of the opening range the opening range does not offer a bias.
The OR break out is a strategy that anticipates the continuation of a stock’s momentum as it trades through the high of the opening range and the high of the day. The high and low of the opening range often represent significant price levels in determining a stock’s direction for the day, and therefore these are good levels to use to establish positions and determine stops. The OR set up can be exploited by many different trading styles including scalping, swing trading, and position day trading (day trades held for a good portion of the trading day). A scalper can trade the volatility, support, and resistance often found at these levels, while a position day trader can use the break out or retracement to the high of the OR to establish a well defined, low risk trade. And the swing trader can use the OR break out time the entry into a trade that met all the longer term criteria of the trade.
The main objective in scanning for the stocks with bullish OR patterns is identify the best stocks to trade as they are breaking out or after they have broken out of their OR. But finding stocks that have a bullish bias is only the first step. Therefore, this strategy lesson will discuss how to analyze the scan’s results to identify the stocks that are likely to continue to trend higher after they break out of their opening range.
The strategy’s scan identifies stocks with the biggest relative volume in the last 5 minutes and in one of two bullish conditions: breaking out of their 30-minute opening range to the upside for the first time today, or trading above their opening range. The scan also requires that the relative volume during the 30-minute OR was greater than 0% which means the stock had greater than average volume in the first 30 minutes of the day.
How to find the best candidates
The first step in analyzing the results of the scan is to identify the stock’s current position relative to the opening range. The opening range pattern icon found in the HotScans “OR Patt.” column will do this for you very quickly. You should become familiar with how to read this icon because it packs a lot of powerful information into an easy to read picture. A complete description of how to read it can be found in the help section under “Opening Range Scans”. The basic interpretation of this icon for the purpose of this strategy lesson is to answer the question of:
“Is the stock breaking out now, or is it trading above the OR after breaking out earlier in the day?”
Here is how the icon answers this question.
If the icon has a yellow arrow then it is breaking out now (during the scan period).
If the icon has a green arrow then the stock broke out prior to the current scan period and it is currently trading above the OR.
As with any trading strategy the execution of it is not as simple as “buy the green and yellow arrow”. The power of filtering for stocks is in its ability to generate a focused list of trading opportunities. The HotScans OR break out scans focus your attention on stocks that have demonstrated that they should be traded with a bullish bias for the day.
Whether you are trading the actual break out or trading the follow through (continuation of a break out) the next step is to determine which candidates are most likely to continue higher by looking at a few characteristics of the stock’s trading action. The best candidates are likely to have at least three of these five characteristics.
Good price action within the opening range. When looking for a potential break out, “good price action” prior to the break out means the stock has a well defined consolidation pattern. This consolidation may cover the whole opening range (high to low), or if the opening range is big, then it may be in the form of a tight consolidation pattern at the top of its range. There are four reasons why tight consolidation is good for this strategy. One, it creates a clearly defined resistance level at the top of the opening range which in turn clearly defines the breakout point. Two, tight consolidation tends to precede powerful breakouts. Three, the well defined resistance will become well defined support should the stock retrace back to its break out point. And finally, tight consolidation helps in the tactics of determining a stop loss point as discussed in the “Tactics for trading the OR break out” section below.
Big relative volume during the breakout. High relative volume (above average volume)
during the breakout is another bullish indication that the stock will continue
higher after its breakout. The relative volume during the breakout is
represented by the Scan Period volume gauge. Scan results are based on a Big
Volume Now scan, therefore the HotScans table is sorted by the stocks with
greatest volume in the last five minutes. This strategy also displays the
relative volume gauge so you can quickly see if the OR volume was big. A
reading of relative volume greater that 300% should be considered big volume.
This is a setting you may want to increase to filter out any stocks with less
that 300% volume if you are focusing only on buying the breakouts as they
Strong price action after the breakout. The
price action immediately after the stock has taken out its opening range
high is the most important and insightful trading action of this strategy.
If you are looking at the 30 minute opening range as the basic scan does,
the duration of this “after the breakout” period is the 15 minutes
immediately after the stock breaks above its opening range.
This period is important is because it represents
the stock telling you how it feels at the new high levels. Strong price action
is demonstrated by a clean breakout followed by either a substantial rally or a
consolidation phase above the opening range for 15 minutes after the breakout.
During this period you are looking for evidence that the stock is comfortable
trading above its opening range. For example, a clean break and rally followed
by an orderly retracement to the breakout level is very bullish price action. A
15-minute consolidation period above the opening range is healthy action which
if followed by another move higher is very bullish.
Don’t fall in love with a stock because it broke out
of the OR with good volume. Watch out for signs of trouble such as bearish
price action. If the stock rejects the new high quickly (within minutes) and
violently by selling off back into the opening range then the breakout is
likely to fail. Another bearish pattern is a consolidation above the opening
range followed by a sell off back down below the breakout point. When a stock
does not demonstrate strong price action after a breakout of the OR should be
considered to have neutral bias at best. Of course if it proceeds to drop below
the low of the OR it is now considered to be in a bearish condition.
High relative volume during the opening range period. High relative volume
for OR period as a whole demonstrates an unusually high level of interest
in the stock for the day. Low relative volume for the whole OR period
should not be considered to be negative, but unusually high volume should
be viewed as a significant characteristic. High relative volume provides
more potential fuel for the breakout when it occurs. Be careful, high
relative volume in the OR is not considered bullish until the stock breaks
out to the upside. If the stock breaks down instead of up this high
relative volume will act as fuel for the sell off! The default setting for
this strategy is scan period relative volume greater than 0%. The basic
strategy displays the relative volume gauge which makes it easy to visually
filter for the highest OR relative volume stocks in the table. This is a
setting you may consider increasing to 300% on days when you are finding
more than enough ideas.
A bullish longer term picture. Even when day trading it is to your
advantage to know whether or not the stock you are trading or considering
to trade is in a bullish conditions on a daily or weekly basis. For the
purposes of day trading this strategy the longer term picture should
simply be considered using some basic trading common sense. This means
look at a daily chart and identify major areas of support and resistance.
Don’t establish a long position right below major resistance. Look for
situations where the stock is currently breaking or has recently cleared a
major resistance level. Or, look for stocks that are bouncing off of major
support levels. For more of a discussion on using support and resistance
refer to the “Using Support and Resistance to Your Advantage” article in
the July 2003 issue of Precision Day Trading.
Trading tactics for the OR breakout
Trading tactics are the rules that a trader applies to a
trade setup to determine when to go long, take profits and cut losses. The
following section is a brief discussion of a tactical approach to trading the
opening range breakout strategy. This is not an outline for a mechanical
system. There are many other ways in which successful traders trade using the
opening range as their guide, but if you are new to the opening range these
basic rules should get you started.
First and foremost – manage your risk.
HotScans will provide you with lots of
candidates for potential trades. If a set up doesn’t meet your risk parameters
then don’t even consider it a potential opportunity and look at the next
candidate! This lesson in intended to be detailed discussion on risk
management, but there are a few basic risk management rules that work well with
the most trading approaches including the OR.
Let’s look at the example below of an opening range breakout
trade on Intel (INTC) on a five minute bar chart. The red and blue horizontal
dotted lines represent the OR high ($24.27) and low respectively. The yellow
circle highlights the well defined consolidation phase right below the high of
the OR. Based on this consolidation, your stop or risk point was $24.11. The OR
high of $24.27 was your a breakout point, so after adding a couple cents to get
your entry point of, $24.29 for example, your risk was the difference between
these two points ($0.18) plus estimated slippage.
Finding your entry points - let the stock tell you when to enter.
Be patient, look for stocks that have more than one of
the trading characteristics discussed above. If you like to buy the breakout as
it’s happening then you will want to see good price action and high volume in
the OR and during the breakout. If you prefer to wait to see confirmation of a
good break then you can focus on the stock’s trading action above the opening
range, and look to enter on a retracement or renewed upward momentum. The INTC
chart above illustrates the following ways the OR provided a roadmap for great
trades based on the OR.