Markets

DAX® – Gaps make the difference! – columns

Gaps make the difference!

Gaps exist in various forms. There are the good gaps, such as the parking space, or the bad gaps, such as the gap in the résumé. However, gaps in the stock market, namely in the course of the share, are undoubtedly positive. The price gaps, referred to in technical jargon as “gaps”, arise in their simplest form when the opening price on a trading day is beyond the closing price on the pre-trading day. Much more impressive, however, are the price gaps that arise beyond the high or the low of the pre-trading day. We have investigated the gaps of the DAX® since the beginning of the millennium and found out some amazing things. We have defined two strategies for this purpose and compared them with the DAX®. In strategy 1, we always open our long position at the DAX® closing price on one trading day and liquidate it again at the DAX® opening price on the following trading day. In strategy 2, we always open our long position at the opening price of a trading day and close it again at the closing price on the same trading day. We refer to strategy 1 as “Gap-DAX®”, while we use strategy 2 as “Intraday-DAX®”.

DAX® (Daily)

Chart DAX®

Source: Refinitiv, HSBC²

5-year DAX® chart

Chart DAX®

Source: Refinitiv, tradesignal²

Mind the gap: stability in difficult market phases

Transaction costs were not taken into account in our backtest. The graphic below shows that the Gap-DAX® has clearly outperformed the DAX® and the intraday DAX® strategy since 2000. At this point we would particularly like to emphasize the robustness of the Gap-DAX® in bear markets. We see a stable course of the strategy, especially during the dot-com crisis. Other drawdowns, such as during the financial crisis of 2008 or the Corona crisis of 2020, were not as serious as with the DAX®. An important reason for the outperformance of the Gap-DAX® strategy is the higher hit rate. While the DAX® has had a hit rate of 52.94% since the beginning of the millennium, the gap strategy achieved a rate of 54.49%. The intraday strategy is only successful in 51.99% of the cases. Looking at the short-term since 2015, we see a similar picture. The gap strategy recovered very quickly after the Corona low in March and even reached new highs, while the DAX® is still struggling with its all-time high. The hit rates for the past five years are the same as the long-term perspective.

DAX® (Daily)

Chart DAX®

Source: Refinitiv, HSBC²

Systematically beat the market with price gaps

So we see a systematic outperformance of the gap strategy over different periods of time. However, we can further differentiate the very simple consideration of our gap and intraday strategy. So far we have only acted in one direction. Since we now know that a gap strategy can generate a strategic return, we could now try to trade both ways. We trade a gap “long” if the opening price of the current period is above the closing price of the last trading day, and we open a short position if the opening price of the current period is below the closing price of the last trading day. We use the same time period as above. A gap strategy that trades both ways has generated a return of 461.57% since 2000. While the DAX® has only gained 6,264 points since then, our strategy has risen to 38,398 points. We achieve a hit rate of 55.38% with an average gain of 7.26 points per day. However – and this is also part of the truth – this extremely active strategy has clearly lost momentum over the past ten years.

DAX® (Daily)

Chart DAX®

Source: Refinitiv, HSBC²

Act on the “important” gaps

It achieved the big gains in the 0s, while in the 10s only slight increases, but more frequent consolidations were observed. The hit rate has also declined since the end of the first decade. Now let’s go a step further. Imposing gaps arise beyond the highs and lows of the pre-trading period. What is the performance of a trading strategy that systematically exploits a price gap beyond the high and low of the pre-trading period? In such a strategy, we trade two signals: we open a long position when the opening price of the current period is above the high of the previous period, and we enter a short position when the DAX® opens below the low of the previous period. This strategy comes to a hit rate of 54.27%, a good percentage point less than the first strategy in which we compared the current opening price with the closing price of the previous period. Due to the significantly lower level of investment – with this strategy, investors are involved in the DAX® on less than 30% of all trading days – a far lower return is the logical consequence. Specifically, investors have achieved an increase of 75.96% since 2000.

DAX® (Daily)

Chart DAX®

Source: Refinitiv, HSBC²

“Courage to take a gap”: It pays off

Investors can beat the DAX® with this strategy too. But with 11,552 DAX® points earned, the result is well behind the first strategy. The reason for this is clearly the lower investment period of only 28.7% of all trading days since the beginning of the millennium. On balance, however, the “gap-high-low” strategy also delivered consistently positive results up to 2015. Since then we have also seen consolidation here. In other words, this strategy has weakened over the past five years. In the current year, a dynamic development is set in again, which could make the most recent period of weakness forgotten. At this point we would like to summarize: With both gap strategies, a systematic DAX® outperformance could be achieved in the past two decades. The aha-effect that no state could be made with an intraday engagement in the last 20 years, makes our results appear in a brighter light. The high hit rate and the crisis resistance of both strategies also contribute to this. So gaps can make all the difference. The consistent courage to leave gaps should therefore also be rewarded with an additional return in the future.

DAX® (Daily)

Chart DAX®

Source: Refinitiv, HSBC²

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