Futures Gap Trading

Markets are not perfectly efficient, especially across closed periods. Gaps occur because: 1) The LSE cash market is closed overnight (16:30 to 08:00 London) while global markets trade, 2) News and events happen overnight affecting sentiment, 3) The overnight FTSE future (01:00-21:00 London) and US/global markets provide price discovery, 4) Opening-auction orders from overnight analysis create imbalances. Gaps represent the market's adjustment to overnight information. They're a feature of discontinuous cash trading, not a market failure - and because the FTSE future trades overnight, the index gap is largely a cash-session-open phenomenon.

No. Be selective: 1) Trade gaps meeting the minimum size threshold (< 0.1% gaps are noise). 2) Skip gaps on news-heavy days until you're experienced with event gaps. 3) Prefer common gaps for filling, which are easier to identify. 4) Skip Monday morning gaps initially (the weekend creates uncertainty). 5) Start with 2-3 gap trades per week, focusing on highest-probability setups. Quality over quantity.

This is normal risk in gap trading. Protection: 1) Your stop is beyond the gap extreme + buffer, so you have a defined max loss. 2) Don't add to a losing position hoping for reversal. 3) If stopped out, don't immediately re-enter the same direction - the gap may be a breakaway type. 4) Accept that some gaps don't fill the same day. Your stop protects against catastrophic loss while allowing the thesis time to work.

Most gaps (70-80%) fill eventually, but 'eventually' can mean days, weeks, or months. Breakaway gaps starting major trends may never fill. For intraday gap trading, focus on same-day fills of common gaps. Don't hold positions for days expecting old gaps to fill. Each day is a fresh trade - if a gap doesn't fill today, reassess tomorrow. Some professional systems track multi-day gap fill, but this requires different capital management.

Quick identification framework: 1) Was there a major overnight news/event? If yes, likely breakaway or continuation, not common. 2) Is the gap within the previous day's range? If yes, likely common gap (fill). 3) Is the gap beyond key support/resistance? If yes, potential breakaway. 4) Check volume in the first 5-10 minutes: high volume = conviction behind the gap; low volume = common gap. 5) When uncertain, wait and observe - gap behaviour in the first 15-30 minutes clarifies the type.

VFTSE (the FTSE 100 volatility index) significantly impacts gap behaviour: 1) Low VFTSE: more predictable market, gaps fill more reliably (75%+ fill rate). 2) Normal VFTSE: standard fill rates (~70%). 3) High VFTSE: erratic behaviour, gaps may extend further or whipsaw, lower fill rate (55-60%). 4) VFTSE spike: gap behaviour unreliable, consider skipping gap trades. Track your gap fill rates by VFTSE regime and adjust strategy accordingly (many traders also watch the US VIX for global risk sentiment).

Statistical analysis generally shows: 1) Monday: lower fill rates (~65-68%) due to weekend news accumulation and uncertainty. 2) Tuesday-Thursday: highest fill rates (~75-80%), most predictable. 3) Friday: moderate fill rates (~70%), traders may be positioning for the weekend. 4) Quarterly expiry days: erratic behaviour, avoid gap trading. Start by focusing on Tuesday-Thursday gaps. Add Monday/Friday after gaining experience.

Previous day's range provides key reference points: 1) Gap opens at previous high (gap up) or low (gap down): strong support/resistance nearby, good fade entry level. 2) Gap opens beyond previous range: potential breakaway, don't fade blindly. 3) Gap into mid-range: typical common gap, moderate fade opportunity. 4) Calculate gap size relative to previous range: gap > 50% of previous range = significant move. Use previous high/low as natural support/resistance for stop placement.

Partial fill approach when: 1) Gap is medium-sized (0.3-0.7%) - may not fully fill same day. 2) Time approaching midday with incomplete fill. 3) Price approaching support/resistance within the gap zone. 4) Your P&L is positive but momentum stalling. Full fill approach when: 1) Small gap (< 0.3%) - high probability of full fill. 2) Strong rejection from gap extreme with momentum toward fill. 3) Gap is clearly common type with no catalyst. Default to partial fill strategy for consistency.

Key differences: 1) Single-stock gaps can be larger and more stock-specific (earnings, RNS announcements, news). 2) Single-stock liquidity is lower - wider spreads at open, more slippage; note there are no retail-liquid single-stock futures in the UK, so single shares are traded via CFDs or spread bets. 3) Single-stock gap fills can take longer (less arbitrage pressure). 4) Index gaps reflect broad sentiment; single-stock gaps can be idiosyncratic. Approach: prefer the FTSE 100 future for gap trading due to liquidity. For shares, only trade large-cap liquid names. Require a larger gap size threshold for shares. Be more patient with fill time.

Model components: 1) Dependent variable: binary (filled/not filled) or time-to-fill. 2) Independent variables: gap size percentile, gap vs previous range, VFTSE level, day of week, the overnight FTSE future range and US futures move, previous day's trend, distance from key levels. 3) Method: logistic regression for probability, survival analysis for time-to-fill. 4) Training: minimum 500 gaps over 3-5 years. 5) Validation: out-of-sample testing, walk-forward analysis. 6) Output: probability score (e.g., 75% fill probability) informing position size and confidence. Update the model quarterly with new data.

Strategy by scenario: 1) High-probability fill (common gap, low VFTSE): sell OTM options in the gap direction - short calls for gap up fill, short puts for gap down fill. Theta decay helps. 2) Breakaway gap continuation: buy ATM options in the gap direction for leveraged directional exposure with defined risk. 3) Uncertain gap resolution: buy a straddle/strangle - profits from a large move either direction. 4) Gap fill with hedged exposure: buy a put (gap up) or call (gap down) as insurance while fading with futures. Consider IV level - options are often expensive at volatile opens. Note FTSE 100 options are listed on ICE; retail access is more limited, so many UK retail traders use spread bets/CFDs with guaranteed stops instead.

Framework: 1) US impact: if S&P 500 futures and the US close move strongly, expect a correlated FTSE gap - the US is the dominant overnight driver for UK indices. 2) Asian correlation: if Japan (Nikkei)/Hong Kong (Hang Seng) are already trading the gap direction, the FTSE often follows, though the US lead dominates. 3) Currency: GBP moves and gilt yields can signal flows affecting equities. 4) Commodity gaps: crude oil gaps strongly affect the FTSE 100 because energy majors (Shell, BP) are heavyweight constituents. Strategy: build a dashboard tracking overnight moves in correlated markets. Strong multi-market alignment increases gap continuation probability. Divergence (the FTSE gapping against global direction) increases fill probability.

Integration approach: 1) Allocation: gap trading typically 10-20% of a systematic portfolio. 2) Correlation: gap trades are short-term, lower correlation with multi-day strategies - good diversification. 3) Risk budget: daily gap risk allocation (e.g., max 2% capital at risk in gap trades). 4) Performance attribution: track gap P&L separately from other strategies. 5) Regime adaptation: reduce gap allocation in high VFTSE or trending markets where fills are less reliable. 6) Edge monitoring: track fill rates monthly; if degrading, reduce allocation or pause.

Warning signs: 1) Fill rate declining consistently (e.g., from 75% to 60% over 3 months). 2) Average fill time increasing (gaps taking longer to fill). 3) False breakout rate increasing (gaps starting to fill then reversing). 4) Strategy drawdown exceeding historical norms. 5) Market structure changes (new trading hours, product changes). Response: reduce position sizes, tighten criteria (only highest-probability setups), investigate the cause. Edge decay can be temporary (market phase) or permanent (structural change). Adapt or pause until conditions improve.