After covering several continuation set ups and reversal patterns over the past several articles we come to gaps.
The very nature of a stock gapping up or down defies categorization as a continuation or reversal pattern. Gaps can be either. A Gap can signal the start of a move, a continuation of a move, or the end of a move.
This is perhaps why there are so many misconceptions about trading gaps despite the popularity to do so. One major misconception is that all gaps will eventually close. This is simply not true. Anyone could see this for themselves by just looking at a few charts. If they did all close trading them would pretty be simple, and this is not the case.
Trading gaps can be dicey. Gaps need to be handled at the most volatile time of the trading day - at the opening bell. While gaps can have an effect on a stock Stock Tips for several days, trading them specifically is usually an intraday trading activity. While avoiding the first several volatile minutes of the trading day is generally good advice, gap traders often have to wade into those 'murkey waters' depedning on their strategy. Opening volatility is due to all the market makers balancing their order flow with orders that have come in overnight from all over the world. Often a news issue that has caused a stock to gap will also bring in unusually heavy orders to buy or sell the stock causing an imbalance and the stock to gap.
The opening bell is the first opportunity to trade a stock that has had stock moving news or earnings and unusual heavy trading can cause chaos before any recognizable trend can emerge. For this reason many traders watch several gaps on their trading platforms for several minutes before they consider taking a trade. They will watch for several minutes using a small time frame like a one or two minute chart and then trade them like they would a breakout or pullback on any other chart.
All these gap examples shown here need to be traded in radically different ways. Each may initially signal a continued, or different direction, and what's more, after the inital shock subsides a stock gapping in one direction can then reverse and trade in the other. This all means you have to be 'on your toes' to trade gaps. While alot can be gained quickly by trading gaps, alot can also be lost just as quick.
So how could you determine which direction a stock may Stock Tips go right after it gaps at the opening? There is a feature of some gaps that can allow them to be traded with small confidence right away. Those that produce a shock or sudden blow to other traders and investors already holding the stock like in the first example of SMOD. This stock gaps down at the open. What do you think buyers the day before of SMOD thought about this? While they experienced the thrill of buying a break out from that consolidation the day before, they are clearly trapped in a big loss now. This will force many holders to sell at this loss to avoid a worse situation. As you can see the situation did become worse for those that did not sell as the stock continued to drop over the day. (And again today.) This pattern is also called a 'bull trap'. (As in 'the bulls got trapped'.) The selling frenzy (see the volume) will also bring in short sellers who 'smell blood in the water'. Both groups will be selling and potential buyers that are aware will also want to hold off as they see this 'falling knife'.
Anorher kind of gap may occur out of a base or while the stock was pulling back. This can be the start of a new move. Volume on these is also usually big as once they are located evryone wants to get in on the move. The gap on AMSC yesterday was probably ignited because of some news, but don't be concerned with what may be causing the gap. The fact that it is gapping in this manner is information enough. After all, we don't trade the news we trade other traders and investors reaction to it; and we already can see the reaction happening in front of us.
Gaps like the ones shown can take on 'lives of their own' and are said to 'be on their own page'. What the general market is doing will often have no effect, at least initailly, on price movement when these events happen. Overall the market could be like the calm deep blue ocean, but in just one area there can be a hurricane going on.
As an additional note do you see AMSC ran right throught the void and was stopped at the next level of resistance? (It is pulling back today so far at the time of this writing.) You cannot see the whole length of the base on the chart, but that base is a couple weeks long and represents formidabe resisitance.
This brings up a reason why 'reading' gaps can be very trickly. If AMSC had gapped up right to that resistance do you think it would have had as easy a time running up some more? As you might guess if you have been following these articles it would have had a very good chance to actually fall from that point as previous holders would have had a chance to sell to perhaps break even. If it dropped enough then short sellers may have also joined in helping to drive it down.
Here is yet another gap that has opportunity for trading. SMSC is a continuation gap. While it is in the direction of the trend it is not yet extended or climatic and therefore is confirmating the bullishness. Hot Tropix (HOTT), is another stock with several recent continuation gaps. You can view it on your trading platform, charting software or stockcharts.com. You can also see how it has become climatic. Many new traders will read or hear that this stock was 'upgraded' and is a 'definate buy', or that some wonderful business reason is going to 'drive it to the moon'; and they will 'jump into the stock' exactly when it is the most dangerous.
Chart courtesy of StockCharts.com
In yesterday's article the chart of SQNM was featured. Comments about it were pointing out how 'extended' and 'climatic' it was. The more extended and climatic a stock chart gets it makes it more vulnerable to large and sudden pullbacks. Perhaps you can see how putting together several concepts, like that of climactic moves and subsequent bull traps can enhance your trading and bring you greater odds of being successful in your trading and investments.
Putting several concepts like this together will be discussed In the next article. Several additional 'amplifiers' will be covered that can be used with all the set ups that have been written about in this series to increase their reliability.
Gaps can be up or down. They can be bullish or bearish. Gaps that go up can also be bearish. Gaps that go down can also be bullish. For these reasons if you want to trade gaps be sure you have a written plan to take only those that you have clearly defined and have tested or paper traded.
Trade with a plan.
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