Opening Range Breakout
Do you want to learn how to trade the opening range breakout with success? The opening range breakout strategy exists for decades, and various trading sites wrote about it before. It is one of the most popular day trading strategies, and many scanners screen for such breakouts. This article is about my observations while trading the ORB in time frames like the 1 minute, 5 minute and 15-minute chart.
What Is an Opening Range Breakout
Before trading an opening range breakout, you need to define your trading time frame. Let's say you want to trade a 5 minute opening range breakout.
Go to your favorite charting platform, chose stock like AAPL, and select the 5 minute time frame.
Now you focus on the first candle of the day within the regular trading hours. This first candle of the day is your reference candle for trading the opening range breakout.
The opening range breakout happens once the price trades through the opening range reference candles high.
That's it, no magic formulas, just a simple breakout strategy with reference to the first n minutes of a day instead of trading the break above the previous day high or all-time-high.
But even if the basic definition is that simple, there are tons of variations on how the opening range breakout strategy can be traded. There are also a couple of things to consider regarding the risk-reward ratio and position sizing. Let's get into it.
Defining the Opening Range
Candlesticks consist of four main price points. The open, high, low and close of the chosen period. Let's say you have a green up-candle as a reference candle. The difference between the high and the close is a wick, the difference between open and low is a wick, and finally, the difference between the close and the open of the candle is called body.
The classic opening range breakout refers to trade the break of the high of the reference candle.
The first candle in the regular trading hour and 5-minute time frame has the following characteristics:
- High: $121 = opening range high
- Close: $120 = opening range close
- Open: $110 = opening range open
- Low: $109 = opening range low
If you are trading the opening range breakout the traditional way, you go long if the price breaks the $121 to the upside.
Trading the breakout through the High of the opening range breakout candle has the benefits that the trader has more time to prepare the trade and that a break of that high is also the break of the current day high's resistance. The disadvantage might be that it is harder to get a good fill when trading the break of the high of the reference candle.
How To Select the Time Frame
Choosing the right time frame for trading the opening range breakout is important. One general rule is the smaller the time frame, the higher the potential and risk.
Open a chart within your trading platform and apply a 1-minute chart, 5-minute chart, 15 and 60-minute chart. Now zoom out and look at the price development since the opening range breakout. You will most likely notice a couple of things:
- The smaller the time frame, the stronger the move looks like, beginning from the first candle of the day
- Often the high and the low of the first candle within the 1-minute chart get's broken.
- The break of the high of the 60-minute chart leads only to incremental price improvements in average
- Movements in the 15-minute time frame often look cleaner
From my experience, it is nearly impossible to trade the 1-minute opening range breakout correctly while monitoring multiple stocks. You would need to set up a trading system to do so. If you focus on one stock, handling the 1-minute opening range breakout is possible, but you still have to be fast.
Unfortunately, it is not only clicking one mouse button or hitting a hotkey to get into the opening range trade. Before you get into it, you need to think about the position sizing, risk, and reward.
Trading a fixed size of shares or a fixed dollar amount doesn't make sense when trading the opening range breakout. Instead, you have to adjust the position size according to the range of your reference candle.
This way, the risk of each trade is the same.
- Position size calculation when using the high and low as reference points: $Risk / (Opening Range High - Opening Range Low) = number of shares
The significant advantage of this methodology is that the $risk per trade is always the same. You need some type of automation to calculate the position size when trading extremely low time frames like the 15 second or 1 minute chart. You can do the math on your own for higher time frames, or you could use an excel-table as a reference.
Three Ways of Managing the Opening Range Breakout Trade
The opening range breakout strategy is powerful and one of my favorite day trading strategies. The opening range with the high and low of a candle is easy to identify. Let's assume that you traded the opening range breakout based on a break of the high of the first 5-minute candle of the day during the regular trading hours.
Now you are long by trading the break of the high of the opening range. But how to manage the trade? Let me show you 3 ways of managing the trade.
Fixed Risk Fixed Target
Your number of shares traded is calculated based on the size of your reference candle. Using a fixed risk and fixed target makes the trade management easy. You set and leave the stop loss 1 tick below the opening range breakout low. Your target also never changes, and you define it on your own.
Let's say you use a risk-reward ratio of 1:2 for this trading strategy. That means that you aim for a $2 profit on each $1 risk. If your risk on the trade is $100, the targeted reward is $200. There are 3 potential outcomes at the end of the day:
- The trade hit the stop loss, and your trade result is -$100
- The trade hit the target, and your trade result is +$200
- The price never got to the target and never hit the stop, and your result is calculated by (trade close price - trade opening price) * share size
Advantages of the Fixed Risk Fixed Target Method
This trade management method is easy to implement. Once the trade is opened, you can use an OCO-order where the first leg is the stop and the second is the target price. Once one leg of the OCO order got filled, the other one is canceled (OCO=one cancels the other). You might have to close the trade around the market close if neither the one nor the other event happened. This is time effective, easy to manage and straightforward.
Fixed Target, Trailing Risk
Again, the number of shares traded remains the same and is calculated based on the OHLC of the reference candle. Let's stay with our example, and you got into the trade by trading the break through the high of the reference candle. You are long, and at first, your stop loss is 1 tick below the low of the reference candle.
Using a trailing stop means that you trail the stop with each finished candle to 1 tick below the low of the newest candle. This works pretty well with high-momentum stocks where you see rapid price movements.
Unfortunately, most often, the low of a candle gets broken if a stock grinds slowly higher. It may happen that your trail stop gets hit, and the market just formed a higher low and then moves higher. In that case, you would be stopped out while looking at the chart seeing that the stock hits a new high.
Advantages of the Fixed Target Trailing Risk Method
A trailing stop loss order has the main benefit that it immediately protects your trade and minimizes the risk, but also the chances decline that you will reach your target directly. The main advantage is that the average loss per trade will decline, and you can use a smaller profit target to reach a good profit/loss ratio anyway.
Fixed Risk, No Target
Some momentum stocks run up 20%, 50% or even 100% right from the open. Using a fixed risk per trade without any defined target can lead to meaningful returns if you hit such a home run.
The most important thing is that you need to have the stop loss in place. None of the money management variations allows you to trade without protection!
So what does fixed risk, no target mean?
We stay with our example where you got long by breaking the high of the reference candle. You now set the stop loss 1 tick below the low of the reference candle. And what is with the target? In this case, you do not use any target, which makes the order entry even easier compared to the fixed risk fixed target method.
This method aims to generate income from a couple of home runs where risk-reward ratios of 1-10 and higher are archived. Many times you will get stopped out, or the price will not move that high. But those home runs happen all the time if momentum unfolds.
Advantages of the Fixed Risk No Target Method
If intense price action unfolds, this method is a game-changer and the most powerful way to trade the opening range trading strategy. The smaller the ORB, the higher the potential multiplier of risk and reward. The trade management process is simple since there is only one stop loss order to set once, and at some point throughout the day, the trade needs to be closed.
Trade Management Conclusion
I used C# and EasyLanguage to code the strategy and trail stop methods. All opening range trade management methods had similar results in $. So it mainly depends on your preferences which way to go. Personally, I prefer stocks with high momentum that move right now with high volume and power.
I don't like it to see if tons of fail breakout happen just to retrace, making a new high, to retrace again, making a new high etc. That's why I prefer watching the price action and trailing my stop loss fast. If the ORB does not work immediately, I usually skip on that. There are other day trading strategies, but the opening range breakout strategy is my favorite breakout strategy around market open.
Opening Range Breakout Strategy Conclusion
The opening range breakout strategy is the most powerful day trading strategy in the first hour of a day. It works best with high-volatile stocks and high-volume gappers. Range breakouts are powerful throughout the day, but nothing compares to the price action within the first 60 minutes of a trading day.
The definition of an ORB is simple, and the trading strategy is easy to understand. The biggest challenges are spotting the right prospect based on the price action to focus on and calculating the correct position size. A day trading scanner like Trade Ideas identifies such opening range patterns quickly.
You can also create a watch list and look at the price action during the first few minutes. Trade automation can help you get into multiple trades simultaneously and trade opening range and general range breakouts after that. But it requires coding skills to implement day trading strategies.
Keep in mind to always test new strategies within a simulated real-time environment. No matter if you trade opening range breakouts, or a gap reversal, or events like an earnings report. You need to test strategies first. If you have 10 traders sitting in the same room trading the same strategy, you will most likely have 10 different results.