Exhaustion Gap Reversal

Entry Logic

• Enter short when a stock gaps up on high volume and then reverses to close below the opening price.
• Confirmation is a bearish engulfing candle on the daily chart.
• Use a daily timeframe for this setup.
• Entry should be below the low of the reversal day.
• This setup works best in a mature uptrend.

Exit Logic

• The profit target is the filling of the gap.
• Scale out 50% when the gap is 50% filled.
• Trail the remaining position with the 10-day EMA.
• Exit if price closes back above the high of the reversal day.
• Exit on a confirmed bullish gap and go.
• Exit if the trade is not profitable within 10 days.
• Exit if the MACD shows a bullish crossover.

Stop Loss Structure

• Place a hard stop above the high of the reversal day.
• A soft stop is a close above the 10-day EMA.
• Maximum dollar loss is $1500 per trade.
• Maximum percent loss is 3% of the account.
• The structural stop is the high of the exhaustion gap day.

Risk Management Framework

• Risk 2% of the account per trade.
• Daily loss limit is 5% of the account.
• Weekly loss limit is 10% of the account.
• Maximum drawdown is 30%.
• Minimum risk-reward ratio is 2:1.

Position Sizing Model

• Use a reduced position size for this high-risk setup.
• Adjust size based on the size of the gap.
• No conviction sizing is used.
• Do not scale into trades.
• Scale out as the gap fills.

Trade Filtering

• Avoid trading this setup on illiquid stocks.
• Requires a large gap up on high volume.
• Trade only stocks that are part of a major index.
• Avoid trading this setup during earnings season.
• Do not trade in markets with no clear trend.

Context Framework

• The daily chart should show an extended uptrend.
• Price should be far above the 50-day SMA.
• The setup should occur after a series of positive news announcements.
• The weekly chart should show overbought conditions.

Trade Management Rules

• Do not move the stop to breakeven until the gap is 50% filled.
• Scale out as the gap fills.
• Do not add to winning trades.
• Be patient, as gap fills can take several days.

Time Rules

• This setup is identified at the end of the trading day.
• The entry is taken on the following day.
• The trade can last for several days to weeks.

Setup Classification

• A+ setup: Large gap up, massive volume, strong reversal candle, extreme overbought conditions.
• A setup: Moderate gap up, high volume, reversal candle, overbought conditions.
• B setup: Small gap up, average volume, some reversal signs.
• C setup: No clear exhaustion gap, avoid.

Market Selection Criteria

• Trade large-cap stocks that are widely followed.
• Minimum daily volume of 5 million shares.
• The stock should have a history of gapping on news.

Statistical Edge Metrics

• Expected win rate is 50%.
• Average win is 3R.
• Average loss is 1R.
• Profit factor is 1.5.
• Expectancy per trade is 0.5R.

Failure Conditions

• The strategy fails if the gap is a breakaway gap and not an exhaustion gap.
• A common failure is a partial gap fill followed by a rally to new highs.

Psychological Rules

• Have the discipline to short a stock that has gapped up strongly.
• Do not get shaken out by intraday volatility.

Advanced Components

• Use options market data to see if there is heavy call buying.
• A news sentiment analysis tool can help gauge the mood of the market.
• Avoid trading this setup on multiple stocks in the same sector.
• The monthly chart should show a potential long-term top.

Location

• The setup is strongest after a multi-month uptrend.
• The setup is weakest in a sideways market.
• The location of the gap in the overall trend is critical.