Can you profit from morning market emotions? The Gap Terrorist strategy takes advantage of downward gaps to seize opportunities before the market reacts. This strategy has an winrate of over 75%.
Inspiration
The Gap Terrorist Strategy was created to address extreme price movements that happen after the market opens with downward gaps. This strategy seeks to pinpoint moments of market panic when the opening price drops below the previous day's low, while technical indicators suggest a reversal.
Key Components
Responding to gap downs at the session opening.
Applying a trend filter.
Identifying a short-term exit signal.
The strategy's results are based on trading four ETFs: SPY, QQQ, XLY, and XLF. However, as the robustness results indicate, it can perform well in the broader stock market.
Even though the CAGR for these ETFs is relatively low, the strategy maintains a low exposure of about 10%. This results in an Exposure Adjusted Return of over 35%.
Backtest 1, Fixed $ Money Management
In this approach, we consistently invest $100k, dividing it among the maximum number of open positions (3 out of 4 available ETFs). This means we commit up to $33k per position.
We are testing the last 30-year period from 1994 to June 2025
Invested capital: $100k
Number of parallel positions: 3
Maximum investment in 1 position approximately: $33k
Tested period in years: 30
Tested years: 1994-06.2025
The tested instrument is a group of 4 ETFs: SPY, QQQ, XLY, XLF
Equity chart for this test:
Basic statistics and results month by month:
Summary of statistics - all data according to the closing date of positions:
Backtest 2, % Money Management
In this backtest, we invest 100% of the current capital in the strategy, starting with an initial capital of $100k. This means the position value changes in proportion to the capital's increase or decrease. All other parameters stay the same.
The Equity Chart for this test and the comparison with the Benchmark are presented below. Open Equity is a red line. Closed equity is a blue area:
Basic statistics resulting from the test:
Trading Strategy Analysis
Net profit i CAGR
The strategy generated a net profit of $210,179 during the analyzed period, while the SPY benchmark achieved a profit of $2,115,715. The strategy's CAGR is 3.72%, significantly lower than SPY's 10.51%. However, due to very low exposure, the strategy results in an Exposure Adjusted Return of 35.7%.
Drawdown and Return/Open Drawdown Ratio
The maximum open drawdown was -11.95%, and the Return/Open Drawdown ratio was 6.41, indicating stable risk management. For SPY, the drawdown was -55.19%, with a ratio of 4.93.
Exposure
The strategy had an average exposure of 10.42% compared to the 100% SPY benchmark. This shows low capital commitment and greater portfolio flexibility. Here's a historical overview:
The study was conducted on the underlying instrument i.e. S&P500 stocks. We measure exposure with a dedicated tool which you can read about here.
Winning Percent
The strategy reached an effectiveness level of 75.71%, which is impressive and shows that the entry signals are highly accurate.
SL & TP
The strategy doesn't use traditional stop-loss (SL) or take-profit (TP) orders. Instead, it exits when the previous day's high is broken or when a time limit for the position is reached. Visit the stop loss order page.
Market Regime
The strategy was tested in all basic market regimes and includes filters implemented based on this. Read more about market regimes.
Trading Costs
Transaction costs and slippage were included in the tests. Check out our latest study on transaction costs using the Alpaca broker here. With a diversified stock portfolio and strategy, transaction costs can determine profit or loss, so it's important to thoroughly test and choose a broker.
Robustness
The strategy successfully passed the parameter modification tests. To enhance its robustness, we minimized the number of parameters. The selection criteria focused on effectiveness and alignment with the strategy's nature.
Robustness tests were conducted on stocks from the S&P 500 and Nasdaq 100 indices, covering the years 1994–07.2025. The %MM was applied and considered in the studies.
A total of 56,498 transactions were conducted for the S&P 500 and 11,211 for the Nasdaq 100. The maximum number of open positions was 100 for the S&P 500 and 50 for the Nasdaq 100.
S&P500 max transactions: 56,498
Nasdaq 100 max transactions: 11,211
Recommended Instruments
Recommended strategy for ETFs: SPY, QQQ, XLY, XLF. This strategy also performs well in the broader stock market.
Pattern Day Trader
The strategy doesn't close transactions on the same day, so it does not meet the Pattern Day Trader (PDT) criteria. This means you can use the strategy without needing to maintain a $25,000 balance and without trading restrictions.
Correlation
To check the correlation of the strategy with others, go to the page dedicated to correlations.
Summary & Strengths and Weaknesses of the Strategy
Strengths of the Strategy
High transaction effectiveness: The strategy has a 75.71% win rate, showing high accuracy in entry signals.
Effective risk management: The maximum drawdown is just 11.95%, and the return to drawdown ratio (Return/DD) is 6.41, outperforming the SPY benchmark.
Low capital exposure: The average capital engagement is around 10%, leading to an Exposure Adjusted Return of over 30%. This allows for the use of other strategies at the same time.
Weaknesses of the Strategy
Low CAGR: An average annual return rate of 3.72% is much lower than the SPY benchmark. To make this strategy valuable, it should be part of a broader portfolio.
Summary
The Gap Terrorist is a trading strategy that trades infrequently but effectively captures buying opportunities after gap-down openings. Based on years of market observations and proven rules, it can be a valuable part of a broader portfolio in volatile market conditions.
What you get in the package for this strategy:
Ebook describing detailed rules and results of the strategy.
SQX file ready to use on the Algocloud and StrategyQuant platforms.
Pseudocode that describes all the rules in an easy-to-understand way.
Disclaimer
The results obtained from historical data do not guarantee future outcomes. The effectiveness of a strategy can change over time. Backtesting is a tool that allows for the analysis and evaluation of an investment strategy based on historical data. Various factors, such as market changes or economic conditions, can influence the effectiveness of a strategy over time.
Investing always involves risk. This material is not investment advice. We share our experience and algorithms for educational purposes. We make efforts to ensure that our algorithms are error-free, but neither we nor the tools we use guarantee the absence of technical issues. Any decisions to use a particular strategy are made at your own risk and should be preceded by careful understanding and verification. You should always carefully consider your investment goals and risk tolerance before making investment decisions.
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