Wednesday, November 16, 2016

Better Opening Range Breakout - the Overnight Gap setup

In my earlier post about Opening Range Breakout, I had mentioned a very simple way to trade the Opening Range Breakout. It was a simple trading system, where upon completion of the ORB period,  entry triggers were placed above and below the Opening Range.

That system had a positive expectancy - both in backtests as well as real trades. I mainly tested and traded that system on Nifty50 futures. The issue with that system was that it was given to huge drawdowns. With optimizations, the win rate ranged between 20% to 30%, with a reward-risk ratio of 4:1 or more.

I have been testing Opening Range Breakout with different parameters, and one of the obvious tasks is to attempt to improve the win rate to minimize drawdowns. This process is still work-in-progress, but let me share one of my findings.

The tests were done on the NIfty50 Future data of the last 4 years. I find that if Opening Range Breakout trades are taken only when there is a significant overnight gap, with a few optimizations, the win rate jumps to between 50% and 55%, though the reward-risk ratio goes down to between 1.6 to 2.0.

Compare the 2 results:

System   My Old ORB System    ORB with overnight gap filter 
Win Rate 20% to 30% 50% to 55%
Reward-Risk Ratio 4.0 to 6.0 1.6 to 2.0

I have given ranges for the Win Rates and Risk-Reward Ratio, but keep in mind that the Win Rates and Risk-Reward Ratios generally have a inverse relationship. So if I optimize the old system for a Win Rate of 20%, then the Risk-Reward Ratio would be closer to 6. Similarly, if I optimize the old system for a Win Rate of 30%, then the Risk-Reward Ratio would be closer to 4.

Which system would you choose? Applying the Kelly Criterion to maximize returns, the choice would generally be to go with the overnight gap filter.

While using the old ORB system, the Kelly Criterion would restrict the capital risked per trade to between 6% to 12%  and have an expected return of 2 to 10 times the initial capital per 100 trades. (The results that I got while trading the system were closer to 2 than 10). With the Overnight Gap filter, due to its higher win rate, the capital risked per trade according to the Kelly Criterion would be 15% or more, giving a minimum expected return of 25 times the initial capital per 100 trades.

But again, let me put the disclaimer. There are no minimums in trading. If you have the bad luck to hit a bad drawdown, or a big slippage, or makes typos, or go psycho... then there are no minimums... psycho gamblers especially have the talent of getting account balances below zero very quickly. Even ignoring all the bad luck and bad psychology, there is no guarantee that the market will continue to behave the way it did in the past to make Opening Range Breakout a successful Trading System. These are estimates based on past data, and not a prediction of the future performance.

Below, is an image on the how the ORB trades with overnight gap filter panned out on the November Nifty50 H1 charts. The Yellow bars indicate the days on which the setup occurred.

Opening Range Breakout with Overnight Gap

I have also found a few setups that can increase the expectancy of Opening Range Breakouts further... but the study is still in progress.


  1. Thanks for the article. You nailed it: ORB systems have a capacity for "hooking" traders because they have an uncanny ability to provide long-term winning streak, followed by equalizing drawdowns - in other words, most of the time being no better than random gambling. Yet there are those seemingly 'endless' wins and profits which tend to confound traders and tease them with the idea that, if only they found the 'perfect filter' or 'correct entry' etc etc. I've been searching for that correct filter for ORB for literally 12 years with no success. And why do I keep coming back to this search? Because the sheer simplicity of a system that is so mechanical (i.e., buy at .50 pts above OR, sell on close) always remains tempting, especially when other systems seem to go nowhere and you get caught in an endless rut. My conclusion? I think we're simply up against far more randommness than we care to admit in trading, and there is no profitable system but buy and hold.

    1. Hi Ronsword,

      Thanks for sharing your thoughts. Yes, trading is random enough to drive me nuts. However, I still have hope of trading (not buy and hold) my way to consistent and huge profits, and that's what keeps me trying at this game.

      Years of trading has taught me that I am not knowledgeable enough to judge anything about trading. To me, many opinions about trading seem to be both true and false at the same time. Like the blind men in the story of "The blind men and the elephant", each of us can have a different (partly true) opinion about trading depending on our individual experiences.

  2. I also share your hope Augu and haven't quite 'given up' yet. I should sayclarify a comment made in my last post, that while there are no 'perfect filters', there are still useful filters. For example one pretty good filter is CCI or Bollinger %b to screen ORB entries (though like all filters, it sometimes misses good opportunities). In this set up, you enter 1 point above/below OR high/low only if CCI and/or %b are also in high/overbought or low/oversold range. Take a look when you have a chance.

  3. Any further analysis on it. I have shared some data point here on gaps.

    1. Hi,

      No, I have not done further analysis on this. Not doing much system testing nowadays. Will get back to testing systems probably after a few months.