Gap Fade with Divergence

Entry Logic

• Exact Entry Trigger: A stock gaps up and makes a new high, but the RSI or MACD shows bearish divergence. Enter short on a break of a 5-minute low.
• Confirmation Requirements: The divergence should be clear. The reversal should be on increasing volume.
• Timeframe Required: 5-minute chart.
• Location Context: The entry occurs after a loss of momentum.
• Market Condition Requirement: A market that is not strongly bullish.

Exit Logic

• Profit Target(s): Target the 50% retracement of the day's range, then the low of the day.
• Scaling Out Rules: Scale out at each target.
• Trailing Stop Rules: Use the 20-period EMA on the 5-minute chart.
• Exit on Signal Failure: Exit if the stock breaks the high of the day.
• Exit on Opposite Signal: Not applicable.
• Exit on Time Expiration: Exit by the end of the day.
• Exit on Momentum Loss: Exit if the downward momentum stalls.

Stop Loss Structure

• Hard Stop Location: Above the high of the day.
• Soft Stop Rules: None.
• Maximum Dollar Loss: 1% of account.
• Maximum Percent Loss: 3% of stock price.
• Structural Stop Placement: High of the day.

Risk Management Framework

• Risk Per Trade: 1% of capital.
• Maximum Daily Loss Limit: 3%.
• Maximum Weekly Loss Limit: 6%.
• Maximum Drawdown Allowed: 15%.
• Risk-Reward Ratio Requirement: Minimum 2:1.

Position Sizing Model

• Recommended Sizing Approach: Based on 1% risk rule.
• Volatility-Based Adjustment: Reduce size in volatile stocks.
• Conviction-Based Sizing: Full size for A+ setups.
• Scaling In Rules: Do not scale in.
• Scaling Out Rules: As defined in Exit Logic.

Trade Filtering

• Market Conditions to Avoid: Strong bull markets.
• Specific Setups Required: A gap fade with divergence.
• Stock/Instrument Requirements: Liquid stocks.
• Time of Day Restrictions: Any time of day.
• Chop/News Avoidance Rules: Avoid news-driven gaps.

Context Framework

• Trend Direction Assessment: Best in range-bound or bearish markets.
• VWAP Relationship: The entry should occur as the stock breaks below VWAP.
• Moving Average Relationship: The stock is often extended from its moving averages.
• Range Location: At the top of the daily range.
• Higher Timeframe Alignment: The divergence should be present on a higher timeframe as well.

Trade Management Rules

• When to Move Stop to Breakeven: After the first target is hit.
• When to Scale Out: At profit targets.
• When to Add Size: Never.
• How to Handle Fast Moves vs Slow Moves: Let the trade play out.

Time Rules

• Optimal Trading Window: Any time of day.
• Times to Avoid: The opening 15 minutes.
• Session-Specific Notes: Works well in any session.

Setup Classification

• A+ Setup Criteria: A clear divergence with high volume reversal.
• A Setup Criteria: A divergence with average volume.
• B Setup Criteria: A weak divergence.
• C Setup Criteria: No clear divergence.

Market Selection Criteria

• Instrument Requirements: Liquid stocks.
• Volume/Liquidity Requirements: >1M daily volume.
• Volatility Requirements: Moderate.

Statistical Edge Metrics

• Expected Win Rate: 60-65%.
• Average Win Size: 2.5R.
• Average Loss Size: 1R.
• Profit Factor: 1.8 to 2.2.
• Expectancy Per Trade: +0.8R to +1.0R.

Failure Conditions

• Market Conditions Where Strategy Fails: Strong bull markets.
• Specific Scenarios to Avoid: Divergences that do not lead to a reversal.

Psychological Rules

• Key Mental Discipline Requirements: Requires discipline to short a stock that is making new highs.

Advanced Components

• Market Regime Detection: Use market internals to confirm weakness.
• Volatility/Liquidity Filters: Avoid illiquid stocks.
• Correlation Filters: Not applicable.
• Multi-Timeframe Alignment: The divergence should be present on a higher timeframe as well.

Location

• Where This Setup Is Strongest: When the divergence is clear.
• Where This Setup Is Weakest: When the divergence is weak.
• Location Changes Outcome: The clarity of the divergence is critical.