SCOTT WELSH TRADING BLOG

The Goodness Of Gaps

The Goodness Of Gaps

Mar. 11, 2015

I’ve always been deathly afraid of gaps.

It makes sense. I’m not fond of risk and I’m not fond of uncertainty. That’s why I only watch replays of Federer matches after I know he’s already won. Watch his matches live? Nope. Something bad might happen.

That’s why I’ve stayed away from gaps. Don’t hold positions over the weekend, that’s my motto. Don’t trade penny stocks after the session has closed. Messing with gaps will destroy your trading account!

And then I did the testing. After thousands upon thousands of tests and hundreds of hours of research, I started to notice something very strange. I started to notice that staying away from gaps could cost me a whole lot of money.

For example, I took a chart that I watch every day.

It has a good profit to drawdown ratio and a good winning percentage.

Now take a look at the same Robot if I take Fridays out. I don’t need to tell you that Fridays are the gap day in forex. If you trade currencies on Fridays, you are putting yourself in “danger”, whereas if you do not trade on Fridays, you never have to fear any gaps and life is so much more certain.

Here’s what happened when Friday trading was eliminated.

The profit to drawdown ratio dropped from 25.4 to 17.7, and the winning percentage has dropped from 79.24% to 78.8%. Not to mention that it makes less money overall.

How can that be? How can adding the uncertainty of potentially hazardous gaps actually make you more profitable?

My first answer is: I’m not sure. It doesn’t seem to make sense.

My second answer is: maybe gapping action is not as dangerous as I thought. Maybe trends that start on Fridays don’t have to be tragically reversed just because traders are away from their computers over the weekend.

Maybe chaotic news events don’t really happen as often as my fearful brain thinks they do.

When I started testing what happens when you trade only on Fridays, I expected disaster. Instead I got results like I mentioned. Profit to drawdown ratio came out greater than 10:1 for the Friday-only USDJPY, and the winning percentage is 89.75%. Wait, what? 89% winners? By trading only on Fridays?? Gaps and all??

But here’s the thing that really blew me away. Consider the Largest Winning Trade and the Largest Losing Trade. In my mind, Friday-Only trading might be possible, but the largest losing trade when you put yourself in danger has got to be catastrophic, right?

Not so. The Largest Losing Trade over an 11-year period was $1,089.31. The Largest Winning Trade? $2,513.95.

The largest loser was well within the maximum drawdown number of $2,300 and the biggest winner was twice that! If you planned for the maximum drawdown with your betting, you could handle the biggest loser and reap the benefits of the biggest winner.

What was I so afraid of again?

I understand being afraid of risk. I understand protecting your account. But maybe, just maybe, our fears are unfounded. Maybe, if we want to really juice our returns, we all need to get some gaps in our lives.

 

Disclaimer:
It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these sites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, the publisher, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.