Strategy Smarts Part 1: Opening Range Breakout
15:43, 8 November 2023
Welcome to our four-part Strategy Smarts series designed to give you some practical trading templates which build on the concepts outlined in our Day Traders Toolbox and Power Patterns series.
We’re kicking this series off with the Opening Range Breakout strategy because it is fundamental to the process of intra-day price discovery.
Strategy Overview:
At first glance, the Opening Range Breakout may appear as a straightforward range breakout trading setup. However, when executed with precision, it can become a potent instrument for harnessing the inherent dynamics of intra-day price action.
The initial minutes of a trading session are marked by frenzied activity, as overnight and pre-opening news gets rapidly factored into prices, and orders are executed. During this phase of early price discovery, a trading range often takes form, aptly termed the opening range.
The Opening Range Breakout strategy comes into play when the market establishes a well-defined range within the first hour of trading.
Here’s a simple 3-step process which can be used as a framework for trading the Opening Range Breakout:
Step 1: Define the Opening Range
The initial and critical step in this strategy is defining the opening range. The method for determining the opening range may vary for different assets, such as stocks and indices or the forex market.
For Stocks & Indices:
Stocks and cash indices with set opening and closing times make defining the opening range relatively straightforward. We are looking for a range to develop within the first hour of trading – the more obvious the range the better.
NOTE: It's important to acknowledge that a range may not always form within the first hour of trading. In such cases, the Opening Range Breakout strategy would not usually be applied by traders using this strategy.
Example: AAPL 5min Candle Chart
Past performance is not a reliable indicator of future results
For Forex:
Forex is the market that never sleeps, this means the New York close rolls straight into the Asian open – making defining the opening range much more subjective.
For most major forex pairs, volume will be lower during the Asian session, increase in early European trading, before away during late morning and increasing again during U.S. trading hours.
There are many interpretations and definitions of the opening range breakout strategy for forex pairs, but perhaps the cleanest method is using the lower volume Asian session as a window in which a range can form.
Example: EUR/USD 5min Candle Chart
Past performance is not a reliable indicator of future results
Step 2: Check Range Location
If you've read our Day Traders Toolbox Part 1 on Previous Day High and Low (PDH/PDL), you understand the significance of these levels in shaping day trading strategies. The location of the opening range concerning PDH/PDL plays a pivotal role in shaping the expectations and management of the Opening Range Breakout strategy.
Assuming PDH represents resistance and PDL signifies support, the relative distance between the opening range and PDH/PDL dictates whether long or short positions are more appealing.
Should an opening range form above the PDH, this strategy suggests longs will be more attractive as the market is consolidating in a position of strength. The opposite applies to when an opening range forms below the prior days low – the market is consolidating in a position of weakness and therefore shorts might look more attractive.
Example Part 1: SPX 5min Candle Chart
Past performance is not a reliable indicator of future results
Example Part 2: SPX 5min Candle Chart
Past performance is not a reliable indicator of future results
Step 3: Trade the Breakout
Once a clear range has emerged within your defined opening window, and you've assessed the range's location relative to PDH/PDL, it's a matter of waiting for and executing a breakout when it occurs.
A breakout can occur either to the upside or the downside. Consider placing price alerts on both sides of the range to ensure you capture the breakout.
Be aware that breakouts from opening ranges may not always be clean. Noise and false breakouts can occur. Therefore, one of the best entry techniques for trading the opening range breakout is the 'Break & Retest' method, as outlined in our Power Patterns series. This approach waits for the breakout to occur and enters during the first pullback.
Stop Placement: You may want to consider positioning your stop within the opening range to account for potential market noise. Advanced traders may consider employing the Average True Range (ATR) for more precise stop placement, as discussed in our Day Traders Toolbox: Part 3 on ATR.
Profit Target: A sound starting point for determining profit targets in the Opening Range Breakout strategy is using the PDH/PDL and daily ATR. If the breakout happens within the prior day's range, set PDH/PDL as initial targets. If the breakout extends beyond the prior day's range, consider using 1 x Daily ATR as your initial target.
Worked Example 1: Tesla Long Opening Range Breakout
Tesla establishes an opening range during the first hour of trading above the PDH, indicating strength. The range is broken to the upside, and the market retests the upper boundary, offering an entry opportunity. A stop is placed within the opening range, and an initial target of 1 x ATR is reached as the price climbs.
TSLA 5min Candle Chart:
Past performance is not a reliable indicator of future results
Worked Example 2: Tesla Short Opening Range Breakout
Tesla forms an opening range just above the PDL. A break and retest of the opening range triggers the entry. A stop is positioned above PDL and within the opening range to accommodate market noise. The initial target of 1 x ATR is achieved as the price descends.
TSLA 5min Candle Chart:
Past performance is not a reliable indicator of future results
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