Over the last quarter-century, the opening range breakout has been one of the most powerful and successful trading tools. Not only did the analysis technique help Larry Williams turn $10,000 into more than $1 million in less than a year, but it achieved cult status with the work of Toby Crabel and his book, “Day Trading with Short Term Price Patterns and Opening Range Breakout.”
The general range breakout strategy requires the identification of a range and its upper and lower level. When price breaks, usually accomapnied by rising volume, and closes above or below one of thes levels, a trade in that direction is taken. Some analysts advocate for using a stop based on 25% of daily Average True Range and others say the mid-point between the 2 range levels is better. The target is typically the height of the range while other traders like to trail their stop to capture as much of the breakout as possible (see below).
According to Charles D. Kirkpatrick and Julie R. Dahlquist (Technical Analysis: The Complete Resource for Financial Market Technicians), roughly half of breakouts that occur from trading ranges retrace back to the breakout point before continuing in the original breakout direction. Combine this with the high rate of false breakouts, and most novice traders lose money on these price gyrations and end up missing the big move when it finally occurs.
What is Opening Range Breakout
The opening range breakout (ORB) is a method of buying at a level above the market open and selling at a given level below. The strategy developed as an outcome of Arthur Merrill’s work on a breakout off the close for the Dow Jones Industrial Average from 1960-1980.
Although the ORB strategy has its variations, they remain the same: To define what is termed the “stretch” or “offset” off the open. Crabel did a lot of his analysis using a fixed stretch off the open. Williams used a percentage of a short-term average range, most commonly a three-day average. Another well-known trader and Futures contributor, Sheldon Knight, used a percentage of the difference between an N-day high and N-day low.
Defining the Opening Range Breakout
Although simpler methods were effective, Crabel also had a dynamic formula for calculating his offset. The goal was to move the breakout point beyond the noise level in the market. His formula was to use the 10-day average of the minimum between the open and low, and the high and open.
Another major contribution of Crabel’s book was providing a framework for testing opening range breakout patterns. It contained a statistical analysis of different patterns triggered by breakouts: A fixed number of ticks above or below the open. These patterns are based on price action over the past one to seven days. There are some patterns that are biased, permitting trading in only one direction. The framework is as follows:
If the price bar range is less than the previous bar range, it is a narrow range (NR) day. These NR patterns looked back over a given number of bars. For example, an NR4 pattern occurs when the range of the current bar is the narrowest in the past three. He also tested against other patterns, such as NR5 and NR7.
The opposite of NR patterns are wide spread (WS) patterns. This occurs when the current range is the widest on the past N bars. Crabel also looked at both inside and outside bars as qualifiers for a breakout.
An inside day is defined as “if the high of the current day is lower than the high of the previous day, and the low of the current day is higher than the low of the previous day.”
An outside day is defined as “if the high of the current day is higher than the high of the previous day, and the low of the current day is lower than the low of the previous day.”
A bear hook occurs “when you have an NR with the open less than the previous bar’s low, and the close is greater than the previous bar’s close.”
A bullhook occurs “when you have an NR with the open greater than the previous bar’s high, and the close is less than the previous bar’s close.”
Crabel studied patterns of consecutive days up and down to see if they were predictive of the next day’s direction. In addition, he tested breakouts under different patterns. All of these were various numbers of ticks off the open. He tested a collection of different offsets in ticks from the open under given setups.
Performance of the ORB
Opening range breakout strategies performed exceptionally well from 1986-88. There was a fundamental reason for this success. Prior to 1988, key reports came out a half-hour before the bond market opened at 8 am, meaning the open expressed the results of the report. After the Chicago Board of Trade changed the bond opening to 7:20 am, this edge was reduced greatly.
Another big difference in the opening range breakout from the 1980s to the early 2000s was that during a good part of this period, most trades occurred during the day session of the open-outcry trading pit.
However, from 2003 to date, the markets have become electronic, with trading 24 hours a day. As liquidity during the overnight hours has increased, particularly since 2008, the open has become less important.
Can Opening Breakout Be Effective In Stocks?
Clearly, the opening range breakout lost its effectiveness during 2008. Although it may seem natural to suspect the financial market crash in 2008, intuition doesn’t necessarily back that up because the system continued to perform badly after the bull run started in 2009. A more plausible reason is a logistical one.
The opening range breakout hinges on the validity of the open, and increased liquidity during the night sessions has rendered the 8:30 am open less relevant. More markets experience a greater portion of their price range overnight. Indeed, most markets that had open-outcry day sessions even a few years ago now trade electronically around the clock. The open does not mean what it did when there was a real pit.
However, there’s another option out there. Individual stocks provide a different picture because stock exchanges do not trade 24 hours - they have stric opening and closing times. While not all stocks do well with this strategy, some perform like true stars e.g. Apple.
Even though Apple has had a great bull run over the past 10 years, this system has made money both on the long and short sides during this time. Apple is a great momentum stock and breakouts off the open at 9:30 am hold well.
Closing thoughts on ORB
Nowadays, trading pits no longer dictate market hours. Most commodity markets trade on a nearly 24-hour basis. Global markets are accessible from almost anywhere in the world via internet. And market response to economic or geopolitical events can take place instantaneously on any business day.
Given these changes, does the market’s “opening range” still hold the same relevance it once held before the digital age? After all, traders don’t have to wait until the traditional market open to trade most markets. They can trade almost any second of the day, on a 24/5 basis, from any timezone.
In a sense, there really is no “opening” if that signifies a starting point from which every trader and financial institution across the globe must synchronously begin. This is probably why the ORB strategy has a low win rate. But equity or stock markets still retain their traditional trading schedule - the morning open and afternoon close.
Although stock index futures may trade throughout the day, on a 24-hour basis, most of the trading volume (for both the stocks and their futures derivatives) occurs during the stock market trading hours. So, no matter where the price of, say, the S&P 500 futures may head during the “overnight” session, once the US stock market opens, any mismatch in price between the stock index and the futures index is typically “resolved” during traditional stock market hours.
This means that the opening range for index futures and individual stocks may still provide an important window of opportunity for any day trader attempting to ride the day’s trend.
Useful Stuff
Download Toby Crabel's “Day Trading with Short Term Price Patterns and Opening Range Breakout.” HERE
Download Crabel NR7 indicator HERE
Download Opening Range Indicator HERE
Comments