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.”
What is Opening Breakout
The opening range breakout is a method of buying at a level above the market open and selling at a given level below. The strategy developed as an outgrowth of Arthur Merrill’s work on a breakout off the close for the Dow Jones Industrial Average from 1960-1980.
Although the 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 Opening Breakout Strategy
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.
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 a.m., meaning the open expressed the results of the report. After the Chicago Board of Trade changed the bond opening to 7:20 a.m., 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 a.m. 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. While not all stocks do well with this strategy, some perform like true stars. These include Apple. “Apple of our eye” (below) shows the result of the Crabel system with an 85% stretch based on trading a 100 lot.
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 a.m. hold well. The equity curve has a great shape with frequent new peaks. If we look at the yearly breakdown of results, we see further evidence of the strength of this approach, with 2002 being the only losing year.
Do Your Testing To See If This Trade Should Be Part of Your Trade Playbook
These results suggest that there still is validity to the opening range breakout trading strategy. Interesting areas of study for future articles include honing the breakout identification and expanding the methodology to include baskets of stocks. We also will explore reference points other than the open and new ways of calculating stretch. Some of these ideas also will allow us to alter the technique to various commodity markets that have moved away from the traditional open-and-close concept. The opening range breakout may have a bright future indeed.
Murray A. Ruggiero Jr. is the author of “Cybernetic Trading Strategies” (Wiley). E-mail him at firstname.lastname@example.org.