Overnight risk and gap math

The price of not watching the screen is that the market moves while you are not watching. A stop-loss order only protects you at prices the market actually trades through. When a stock closes at $50 and opens at $44 the next morning, your stop at $48 fills at $44, not at $48. Swing traders live with this every night, so the arithmetic needs to be automatic.

Where gaps come from

Gaps happen when information arrives while the market is closed and the opening price reflects it all at once:

• Earnings reports, almost always released before the open or after the close.
• Company news: guidance cuts, regulatory decisions, deals, management changes.
• Macro news that moves the whole market: central bank decisions, jobs data, geopolitical shocks.
• Sympathy moves: a competitor reports and the whole group reprices.

Futures, forex and crypto trade nearly around the clock, so their "gaps" are smaller and rarer, but weekend gaps in futures and crypto are real, and forex gaps at the Sunday open after weekend news.

The arithmetic

Planned risk assumes the stop fills where you put it. The real loss when a gap jumps your stop is:

real loss = shares × (entry − opening price)

Take a $20,000 account, 1% risk, so $200 at risk. Entry $50, stop $48, distance $2, so 100 shares, a $5,000 position.

A 30% gap on a stock you sized for a 4% stop turns one trade into a 7.5% account loss. That is the whole reason swing traders cap position size independently of the stop, which Module 6 covers in detail.

Gaps go both ways

The same table works in reverse. A position that gaps up 12% on good news has handed you 3R overnight without you doing anything. Over a year, a swing trader who holds sensible-sized positions through normal news will collect a mix of favourable and unfavourable gaps. The ones that kill accounts are the unfavourable gaps in oversized positions.

Gap against you, sized right       Gap against you, sized wrong
                                   
$50 |‾‾‾‾|                         $50 |‾‾‾‾|
    |    | stop $48                    |    | stop $48
$44 |    |___ open, -$600              |    |___ open, -$3,000
    5% position, 3% account loss       25% position, 15% account loss

Same stock, same gap, same stop. The only variable was position size.

Key idea: A stop limits your loss only at prices the market trades through. Overnight, the position size is your real stop.

Practical gap rules

These are the rules this course uses; you can tighten them but should not loosen them until you have a year of records:

1. Know the earnings date before entry. Every candidate on the watchlist has its earnings date written next to it. No exceptions.
2. Cap any single position at 20% of the account, and at 10% for anything that reports earnings inside your expected holding period, trades under $10, or has a history of 20%+ gaps.
3. Assume a 20% adverse gap when sizing anything held through a known event. If a 20% gap would cost more than 3% of the account, the position is too big or the event should be skipped.
4. Never add to a position after the close to "get ahead" of news. If the trade needs the news to work, it is a bet, not a setup.
5. Diversify overnight exposure. Five positions of 8% each face five independent gap risks. One position of 40% faces one. The five will hurt less on average and far less at the worst.

The reframe

Most people meet gap risk as a reason to fear holding overnight. That fear is why they day trade and pay the costs the next lesson describes. The better reading is that gap risk is a sizing problem, and sizing problems have arithmetic solutions. Decide the maximum acceptable damage from a bad gap, back out the position size that respects it, and then holding overnight becomes a routine cost of doing business rather than a source of dread.

Try it: Take your last five trades, or five hypothetical ones. For each, compute the real loss if the stock had opened 15% below your entry the next morning. Express each as a percentage of the account. If any exceeds 3%, write down the position size that would have kept it under 3%.

Recap

• Stops fill at the opening price after a gap, not at the stop price.
• Real loss = shares × (entry − open); size, not the stop, controls the damage.
• Cap single positions at 20% of the account, 10% for anything with event or gap history.
• Know every earnings date before entry and size for a 20% adverse gap through events.
• Gap risk is a sizing problem with an arithmetic answer, not a reason to avoid holding overnight.