The Gap Fade Strategy is a popular price action trading technique that seeks to profit from the tendency of markets to “fill the gap” after an opening price gap. This strategy is based on the principle of mean reversion—where prices often retrace to a previous close after overreacting to overnight news, earnings, or sentiment.

It is especially effective for intraday traders, index traders, and FX traders who look for short-term reversals early in the trading session.

What Is a Gap in Trading?

A gap occurs when the market opens significantly higher or lower than its previous closing price, creating a visible space (gap) on the chart.

Types of gaps:

• Gap Up: Today’s open is higher than yesterday’s high
• Gap Down: Today’s open is lower than yesterday’s low

A gap fill happens when price retraces back to the previous day’s close, effectively “fading” the gap.

Why the Gap Fade Strategy Works

• Gaps often result from emotional or overreactive trading
• Many gaps lack institutional follow-through, making them unsustainable
• Retail traders chase gap moves, but smart money waits for a pullback
• Mean reversion is a natural tendency in liquid markets like indices, forex, and commodities

The strategy aims to exploit this by entering against the gap direction, targeting the prior close.

How to Trade the Gap Fade Strategy

1. Identify a Valid Gap at the Open

Use 15M or 5M charts at market open:

• Look for a gap of at least 0.5% – 1% from the previous close
• The larger the gap, the more likely the fade (unless driven by major news)
• Ensure the gap is not part of a strong trend continuation (see “When to Avoid”)

Mark the previous day’s close as the fade target.

2. Confirm with Price Action

Once the market opens:

• Look for reversal candlestick patterns (e.g. pin bar, engulfing, doji)
• Watch for failed breakouts or rejection candles near the gap edge
• Use VWAP or opening range breakout failure as extra confirmation

Only enter when price begins to stall or reverse, not on momentum continuation.

3. Enter the Trade

For Gap Up Fade:

• Sell/short after confirmation of rejection (e.g. bearish engulfing)
• Target = previous day’s close

For Gap Down Fade:

• Buy/long after bullish reversal signal
• Target = previous day’s close

Stop-Loss:

• Just beyond the gap extreme (today’s high/low)
• Or above/below the reversal candle

Take-Profit:

• Full gap fill (yesterday’s close)
• Or use trailing stop as price reverts

4. Add Confluence for Higher Probability

Improve success rate by combining with:

• Overbought/oversold RSI or Stochastics
• Volume spikes showing reversal pressure
• Support/resistance zones overlapping the gap
• No major macro news sustaining the gap

The more factors supporting reversion, the better the trade.

5. Avoid Low-Probability Gaps

Do NOT fade gaps when:

• Gaps are driven by major earnings or economic news
• Price gaps and continues trending with volume
• The broader market has a news-driven sentiment shift
• Pre-market volume is high and confirms the gap move

In these cases, it’s better to wait for a pullback continuation or avoid trading entirely.

Strategy Summary Table

Component	Details
Setup Type	Mean reversion at open
Best Instruments	Indices (S&P 500, DAX), FX majors, liquid stocks
Entry Criteria	Rejection of gap move + reversal pattern
Stop-Loss	Beyond gap extreme or reversal bar
Take-Profit	Previous day’s close (gap fill)
Timeframe	5M–15M intraday execution
Risk Management	Avoid gap fading into strong news or trending moves

Example: Fading a Gap Up on the S&P 500

• SPX opens 1% higher on mild overnight news
• Price fails to break higher and prints bearish engulfing candle on 5M
• Trader shorts with stop above day high
• Price reverts over the next 30–60 minutes, filling the full gap
• Full risk-to-reward achieved

Conclusion: Fade the Hype, Trade the Reversion

The Gap Fade Strategy is a disciplined, price-action based approach to taking advantage of emotional overreactions in the market open. By waiting for confirmation and aligning with natural market reversion behaviour, traders can profit from quick intraday moves with clear entry and exit logic.

To master gap trading and other high-probability intraday setups, enrol in our Trading Courses at Traders MBA and learn to trade structure, psychology, and price with precision.