Over the last quarter century, the opening range breakout has been one of the most powerful and successful trading tools. Not only did the analysis technique help Larry Williams turn $10,000 into more than $1 million in less than a year, but it achieved cult status with the work of Toby Crabel and his book, Day Trading with Short Term Price Patterns and Opening Range Breakout.

The opening range breakout is a method of buying a given level off of the market open and selling a given level below. The strategy developed as an outgrowth of Arthur Merrills work on a breakout off the close for the Dow Jones Industrial Average from 1960-1980.

Although the strategy has its variations, they remain the same: To define what is termed the stretch or offset off the open. Crabel did a lot of his analysis using a fixed stretch off the open. Williams used a percentage of a short-term average range, most commonly a three-day average. Another well-known trader and Futures contributor, Sheldon Knight. used a percentage of the difference between an N-day high and N-day low.

Defining the strategy

Although simpler methods were effective, Crabel also had a dynamic formula for calculating his offset. The goal was to move the breakout point beyond the noise level in the market. His formula was to use the 10-day average of the minimum between the open and low, and the high and open.

Another major contribution of Crabels book was providing a framework for testing opening range breakout patterns. It contained statistical analysis of different patterns triggered by breakouts: A fixed number of ticks above or below the open. These patterns are based on price action over the past one to seven days. There are some patterns that are biased, permitting trading in only one direction. The framework is as follows:

1. If the price bar range is less than the previous bar range, it is a narrow range (NR) day. These NR patterns looked back over a given number of bars. For example, an NR4 pattern occurs when the range of the current bar is the narrowest in the past three. He also tested against other patterns, such as NR5 and NR7.
2. The opposite of NR patterns are wide spread (WS) patterns. This occurs when the current range is the widest on the past N bars. Crabel also looked at both inside and outside bars as qualifiers for a breakout.
3. An inside day is defined as if the high of the current day is lower than the high of the previous day, and the low of the current day is higher than the low of the previous day.
4. An outside day is defined as if the high of the current day is higher than the high of the previous day, and the low of the current day is lower than the low of the previous day.
5. A bear hook occurs when you have an NR with the open less than the previous bars low, and the close is greater than the previous bars close.
6. A bull hook occurs when you have an NR with the open greater than the previous bars high, and the close is less than the previous bars close.