The Opening Range Breakout (ORB) is a well-established trading strategy for day traders. This post details observations when trading ORB on short term timeframes such as 1 minute, 5 minute and 15 minute price charts.
Opening range
After the first bell, stock trading usually sees some of the biggest price swings of the day. It is not unusual for the first 30 minutes of trading to set the tone for the rest of the session, determining whether it is volatile with high volume or calm with low volume.
There are various definitions of what an open range means, but the most common is that it refers to the gap between the low and high prices in the first 30 minutes of trading. During this time, the range may expand, but this is normal; what matters is what the highest and lowest prices are at the 30-minute mark.
Any basic charting package can do the job for you with candles. There are four key price points in a candlestick; opening, high, low and close of the selected period.
Let’s imagine that your reference candle is a green rising candle. The wick is a thin line that appears above and below the body of the candle and highlights the highest and lowest price points. The body marks the opening and closing price. If the closing price of the period is higher than the opening price, the body will be green. It is red when the last price for the period measured by the candle is below the opening price.
An opening range breakout occurs if price crosses the highest or lowest wick after the first 30 minutes.
Example:
During the first 30 minutes of the trading session, this is the price data for ABC stock:
- $121 is the high of the opening range.
- $120 is the closing price for the opening range.
- $110 is the first price of the opening range.
- $109 is the low of the opening range.
If you trade a breakout of an opening range in the traditional way, you buy a stock if the price rises above $121 and sell the stock if the stock falls below $109. Strange is very simple, so don’t overdo it! While the strategy is simple, you should focus on trading tactics, including position sizing and what you do after opening a trade.
Position size
Trading a certain number of stocks or a fixed dollar amount doesn’t make much sense when trading a breakout of the opening range. Instead, you should resize the position to match the range of your reference candle.
As a result, each trade has the same risk. The goal is to normalize the trader’s risk on each trade so that trading high-priced stocks is no more risky than trading low-priced stocks.
When using the low and high as breakpoints, use the following formula to calculate position sizing:
Number of Shares = $Risk / (High Open Range – Low Open Range).
The dollar risk per transaction is always the same, which is a significant advantage of this system. Of course, the dollar risk should be a small percentage of the account value. In professional trading, anything above 1% is considered extremely risky and most traders prefer to risk a maximum of 0.5% of the account size.
Less risk does wonders for your mental and emotional well-being. This also means that you can be wrong several times in a row and the cumulative losses will have minimal impact on your account. Survival is the first rule of trading.
Three Approaches to Trading Open Range Breakouts
The opening range is easy to determine by looking at the high and low of the candle. Let’s assume that the price exceeds the high price of the opening range, and your strategy means that you buy the stock. But how to manage trade? A trader can do three things.
Fixed risk, fixed goal
Use the height of the reference candle to calculate the number of shares traded. Using a fixed risk and a fixed target simplifies trade management. You place a stop loss one tick below the low of the breakout of the opening range and leave it there. Your goal is also constant; the goal is to potentially “win” twice as much as the potential loss that the trade incurs.
Let’s say this method of trading has a risk to reward ratio of 1:2. This means that you want to make a profit of $2 for every $1 risk. The target reward for a $100 risk trade is $200. There are three possible outcomes at the end of a trading session:
- Your trading result is -$100 because the trade hit the stop loss.
- The trade reached its target and you made a profit of $200.
- The price hits neither the stop nor the target. In this case, we can calculate your result using the formula (selling price – buying price) * share size.
Benefits of Fixed Target with Fixed Risk
This form of trade management is easy to use. You can use an One Cancels Another (OCO) order after the trade has been opened, with the first part being the stop and the second being the target price. If the share price activates one part of the OCO order, the other part is cancelled. If none of these events occur, you may have to close the trade before the market closes.
Fixed Target, Rolling Risk
The number of shares traded remains the same and is determined using the Open, High, Low, and Close of the Reference Candlestick (OHLC). Continuing with our example, you entered a trade on a breakout of the high of the reference candle, you entered a long position and placed a stop loss.
When you use a trailing stop, you move the stop one tick below the low of the most recent candle with each completed candle. This process works well with high momentum stocks that move quickly and in some cases continue to rise throughout the trading day.
Benefits of Fixed Target, Rolling Risk
The most significant benefit of a trailing stop loss is that it immediately protects your trade and reduces risk. However, it also reduces your chances of reaching the goal directly. The biggest benefit is that your average loss per trade will decrease and you will be able to achieve a stable profit/loss ratio.
Fixed risk, no goal
Some momentum stocks rise 20%, 50% or more on their first trading day. If you are successful, using a fixed risk per transaction without a specific goal can lead to significant profits.
The most important thing to keep in mind is the presence of 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 that if you get stopped, how much you will lose. Learning to think about probabilities and bet sizes is an important milestone for any trader on their journey to profitability, and Annie Duke’s Thinking About Betting is a great book on the subject. So what does “fixed risk, no goal” really mean?
We will focus on our example of opening a long position by breaking the high of the reference candle. Stop loss is set, so what to do with the target? If you don’t use a target, entering an order becomes much easier than using the fixed-risk fixed-target method.
This method generates income from multiple home runs with a high risk to reward ratio of 1 to 5 or higher. Often you will be closed, or the price will not rise to this level. However, if momentum develops, it will sometimes continue until the next trading session.
Once in a winning trade, it would be wise to turn it into a swing trade, allowing the market to guide you further into profit. If it works, why close the deal ahead of time? Sit tight with these trades and count your blessings, they don’t happen very often but they can be very lucrative when they do.
Benefits of fixed risk without a goal
This method is a game changer and is the most effective way to trade an open range trading strategy with strong price action. The lower the ORB, the higher the potential risk reward multiplier. The trade management method is simple because you only need to place one stop order with the option to close the trade during the day or leave it overnight if it works well.
The opening range breakout strategy is the most powerful intraday trading strategy in the first hour of the day. Stocks with high volatility and high volume gappers are the best candidates. During the day, range breakouts are strong, but nothing compares to price action 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 trading method. The biggest challenges are identifying the right stocks to focus on based on price action and calculating the correct position size.
Create a watchlist and monitor price action for the first few minutes. Trading automation can help you enter many trades at the same time, as well as range open and break the overall range. Some coding experience is very helpful.
Remember that you must constantly test new strategies in a simulated real-time context. It doesn’t matter if you trade opening range breakouts, gap reversals, or events such as P&L reports. First you have to test your money strategies. Nothing beats the emotional and tactical challenge when you risk your hard-earned money in the stock market.
This article originally appeared on Wealth of Geeks.