Expert Trader Strategies: Opening Price Principle

Through years of observation, veteran trader Larry Pesavento noticed how the first trade of the day often serves as support or resistance for the entire session. He explains a powerful tape reading technique in his 2000 book "Opening Price Principle: Best Kept Secret on Wall Street." The opening price principle has many applications, whether you are playing stocks or futures. (See also: Support and Resistance Basics.)

Pesavento focuses his study on S&P 500 index futures, but most liquid markets benefit from the analysis, especially when intraday ranges set into place. It's a tougher process with currencies because forex crosses trade through 24-hour cycles, with no universally agreed opening or closing prices. Even so, the first forex print of the week – on Sunday night in the U.S. and Monday elsewhere – can be used effectively for the same purpose. (See also: Gauging the Strength of a Market Move.)

The principle works in many ways but shows its greatest value when price returns to test the opening print, from above or below, after it has established a morning trading range. That progression can take between 30 minutes and two hours, depending on volatility. Once in place, draw three lines across 5- or 15-minute charts, at the range high, range low and opening print. Relative positioning between these levels yields all sorts of useful information and trading signals. (See also: Analyzing Chart Patterns: Why Charts?) 

The simplest application comes when price retraces to those levels during the intraday session. Watch closely for small-scale breakouts, breakdowns, reversals and failures, using those swings as short-term entry and exit signals. It's easier than it sounds, because you are looking for the same type of action expected at larger-scale support or resistance, i.e. price expansion when the level breaks or a thrust in the opposite direction when the level holds. The range high and low then come into play as trade filters, depending on their locations relative to the opening tick. (See also: The Anatomy of Trading Breakouts).

Let's see how this works in two common intraday scenarios.

The Powershares Nasdaq 100 Trust (QQQ) gaps up to $102.54 on Jan. 13 and rallies to $103.62 at around 10:50 a.m. That action establishes a morning range, with the swing low occurring at the same price as the opening print. A slow decline then sets into motion, triggering a test at the opening print in the middle of the lunch hour. The fund bounces for 30 minutes and rolls over, retesting the pivot around 1:20 p.m. The solid downside thrust confirms a breakdown that yields a nasty intraday decline.

The failed bounce over the lunch hour completes a bearish cup and handle pattern that adds reliability to short positions taken when price breaks the opening print and range low. It is important to note that breakdowns yielding sizable intraday swings can often be traded for several days because they continue to act as resistance. Similar dynamics apply to opening price breakouts. (See also: Analyzing Chart Patterns: Cup and Handle.)

Gilead Sciences, Inc (GILD) stock gaps down on Dec 9, opening at $103.50 and establishing a morning range between $102.28 and $104.47. Note how the opening print is located between the first swing high and low of the session, setting up different tape dynamics than the QQQ example. In this case, a violation of the first print should have less impact because obstacles to movement are waiting, higher and lower.

The first 5-minute bar establishes the morning range, but that is not obvious until it is tested successfully for around 45 minutes into the trading day (red circle). In turn, the next upswing tests the opening tick, yielding a breakout that adds more than 60 cents in the next 10 minutes. Price promptly stalls at the range top, completes a bullish cup and handle pattern and breaks out in a strong directional thrust that fills the gap and keeps on going into the closing bell.

The three data points bring order into typical morning chaos, allowing you to set first strategies into motion while the majority is struggling to evaluate the market tone. This extra insight generates a well-defined trading edge that adds predictive power in very short time frames, giving you a leg up on the path to profitability.

The first trade of the day in liquid markets defines a narrow price level that can act as support or resistance for the entire session. This opening price principle has numerous applications when used in conjunction with the intraday trading range. (For additional reading, check out: How to Create Profitable Short-Term Gap Strategies.)