The opening range breakout (ORB) is an established trading strategy for day traders. This post details observations while trading the ORB on short term time frames such as 1 minute, 5 minute and 15 minute price charts.
The opening range
After the opening bell, stock trading usually sees some of the most significant price swings of the day. It is not uncommon for the first 30 minutes of trading to set the tone for the rest of the session and determine whether it will be volatile at high volume or calm at low volume.
There are several definitions of what the opening range means, but the most common is that it refers to the gap between the low and high price of the first 30 minutes of trading. During this time, the range may expand, but that’s okay; it’s about what the highest and lowest prices are after 30 minutes.
Any basic stock charting suite can do this job for you through candlesticks. There are four main price points in a candlestick; the selected period is open, high, low and closed.
Imagine your reference candle is a green up candle. The wick is the thin line that appears above and below the body of the candle, highlighting the highest and lowest price points. The body marks the opening and closing price. If the price for the period closes at a higher price than the open, the body is green. It is red when the last price for the period the candle is measuring is below the opening price.
A break from the opening range occurs if the price crosses the highest or lowest pit after the first 30 minutes.
Example:
During the first 30 minutes of the trading session, this is the price data for ABC stocks –
$121 is the opening range high. $120 is the closing price for the opening range. $110 is the first prize of the opening range. $109 is the opening range low.
If you trade the breakout of the opening range in the traditional way, you will buy the stock if the price rises above $121 and sell the stock if the stock price falls below $109. The strange is very simple, so don’t think too much about it! While the strategy is simple, your focus should be on trading tactics, including positioning and what you do after opening the trade.
Position Dimensions
Trading a certain number of shares or a fixed dollar amount makes little sense when trading the opening streak. Instead, you need to adjust the position size according to the range of your reference candle.
As a result, every trade carries the same risk. The goal is to normalize the trader’s risk on every trade, so trading a high-priced stock is no riskier than a low-priced stock.
When using the low and high as reference points, use the following formula to calculate the position size:
The number of shares = $Risk / (Opening Range High – Opening Range Low).
The $risk per trade is always the same is an important advantage of this system. Of course, the $ risk should be a small percentage of the value of the account. In professional trading, anything greater than 1% is considered exceptionally risky, and most traders prefer to risk a maximum of 0.5% of the account size.
A smaller risk works wonders for your mental and emotional well-being. It also means that you can make multiple mistakes in a row and the combined losses will have minimal impact on your account. Survival is the first rule of action.
Three approaches to trading the opening range breakout
It is easy to identify the opening range by looking at the height and depth of a candle. Let’s assume the price is above the high price of the opening range, and your strategy means you buy the stock. But how should the trade be managed? There are three things the trader can do.
Fixed risk, fixed target
Use the height of the reference candle to calculate the number of shares traded. Using a fixed risk and target simplifies trade management. You place your stop-loss one tick below the opening range breakout low and leave it there. Your aim is also constant; the goal is to potentially ‘win’ twice as much as the potential loss incurred by the trade.
Let’s say this trading method has a risk-reward ratio of 1:2. That means you want to make $2 profit on every $1 risk. The targeted reward for a trade with a $100 risk is $200. At the end of the trading session, there are three possible outcomes:
Your trading result is -$100 because the trade has reached the stop loss. The trade has reached its target and you have made a profit of $200. The price has reached neither the stop nor the target. In this case we can calculate your result by (selling price – buying price) * the size of the share.
Fixed Risk Benefits Fixed Target
This form of trade management is easy to apply. You can use a One Cancels the Other (OCO) order after the trade has been opened, with the first leg being the stop and the second leg being the target price. If the stock price activates one part of an OCO order, the other part is canceled. If none of these events occur, you may need to close the trade around the close of the market.
Fixed target, lingering risk
The number of shares traded remains unchanged and is determined using the Open, High, Low and Close (OHLC) of the reference candle. Continuing with our example, you entered the trade by trading the breach of the reference candle high, you are long and your stop loss is placed.
When using a trailing stop, move the stop one tick below the low of the most recent candle on each completed candle. The process works well with high momentum stocks that see rapid price changes, and in some circumstances the price continues to rise throughout the trading day.
Fixed target benefits, trailing risk
The main advantage of a trailing stop-loss order is that it protects your trade immediately and reduces risk. Yet it also reduces your chances of directly reaching your goal. The biggest advantage is that your average loss per trade will decrease and you can achieve a solid profit/loss ratio.
Fixed risk, no target
Some momentum stocks are up 20%, 50% or more on the first day of trading. If you hit a home run, using a fixed risk per trade with no defined target can yield significant returns.
The most crucial thing to remember is to have a stop loss – you should not trade without protection. While you cannot predict how much profit you can make with this tactic, you do know how much you will lose if you are stopped. Learning to think in odds and bet sizes is a milestone for any trader on their journey to profitability, and a great book on the subject is Thinking in Bets by Annie Duke. So, what does “fixed risk, no target” actually mean?
We’ll stick with our example of going long by breaking the reference candle’s high. The stop loss is now set, so what’s the deal with the target? If you don’t use a target, entering orders is much easier than with the fixed risk fixed target method.
This method generates income from a few home runs with high risk-reward ratios of 1-5 or higher. Often you will be locked out or the price will not rise to that level. However, if momentum develops, it will occasionally continue until the next trading session.
Once in a winning trade, it would be smart to turn it into a swing trade so that the market can take you further to profit. If it works, why close the trade early? Stick with these trades and count your blessings, they are uncommon but they can be very profitable if they do.
Benefits of Fixed Risk, No Target
This method is a game-changer and the most effective way to trade the opening range trading strategy when the price movement is severe. The smaller the ORB, the greater the potential risk-reward multiplier. The trade management method is simple as only one stop-loss order needs to be placed, with the option to close the trade during the day or leave at night if it works well.
The opening range breakout strategy is the most powerful day trading strategy in the first hour of the day. High volatility stocks and large gappers are the best candidates. There are powerful breakouts in the range during the day, but nothing compares to the price activity in the first 60 minutes of a trading day. The ORB approach can also be combined with the gap and go strategy.
The definition of an ORB is simple, as is the method of trading. The most difficult tasks are identifying the right stocks to focus on based on price action and calculating the right position size.
Make a watchlist and follow the price action for the first few minutes. Trade automation can help you enter many trades simultaneously and trade open range and general range breakouts. Some coding experience is very helpful.
Remember that you need to constantly test new strategies in a simulated real-time context. It doesn’t matter if you’re trading opening range breakouts, gap reversals, or events like earnings reports. You need to put your strategies to the test with money first. Nothing can mimic the emotional and tactical challenge of risking your hard-earned cash in the stock market.
This article originally appeared on Wealth of Geeks.
Jeff is a fan of all things finance. When he’s not changing the world with his blog, you can find him on a run, playing a Mets game, playing video games, or just playing with his kids.
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