GAPS, GAPS, GAPS...(part 1) Over the next
few sessions we are going to review gaps in price and how they are affected by
and affect future trading.
Gaps can occur in all time frames and in a number of varieties.
Daily gaps occur when there is significant news that causes broker pre-market
bid and ask orders to be significantly above or below the previous nights close.
Gaps occur on individual equities, but we will limit our discussion to broad
market gaps such as the DOW (rare), SP500 (frequent) and the NDX or it's proxy
the QQQ.
Intraday gaps occur in these same indices when there is significant news DURING
the day, i.e. an FOMC surprise rate cut that comes out in mid session or a rumor
that spreads like wildfire across the trading floor, (i.e. Osama discovered
hiding in a girl's school in Alexandria Virginia).
Lets tackle the Opening Gaps.
First of all we have to understand opening and closing prices....Contrary to
belief, these are not the first and last prices of the day. They are actually
computed from the range of price and number of transactions occurring at various
price levels during the first and last 30 seconds of the trading day. That's why
many times if you watch minute by minute price charts you will see a wide
variance in reported opening price from reporting services. Ultimately they all
settle on a price to report.
The opening gap and the next 20-25 minutes is by far the most difficult to
trade, yet the one trade that can prove to be THE most profitable trade of the
day for daytraders.
This little treatise is by no means intended to teach you to trade the opening
gap. I traded it quite successfully for many years, but without the proper
hardware and software (physical and mental), it is too much of a roller-coaster
ride for most to be able to learn to cope with.
Rather we will look at what effect these gaps can have on longer term trading
when they remain unfilled for hours, days, weeks or even months and years. The
reason is that these gaps act like price magnets to draw price to them when they
get within the "attraction" range.
Before we leave opening gaps, just a few notes.
Most opening gaps are filled the same day...over 60% of the time
An up gap leads to higher closing prices the same day 60% of the time
A down gap leads to lower closing prices the same day 70% of the time
Traders will usually countertrade the opening gap 15 to 20 minutes into the
trading day for a scalp trade.
If the gap doesn't get filled in the first half hour, then most of the time the
market will close in the direction of the gap opening on the day.
NEXT? Types of gaps and what causes them....
:: Henry Ford ::
GAPS,GAPS,GAPS (Part2)...
What types of gaps are there?
Basically five different classes;
Area
Breakaway
Continuation
Exhaustion
Ex-dividend(rare and of little significance)
These can be further defined as FULL or PARTIAL GAPS. In a FULL GAP, price gaps
open below or above the previous days high or low. In a PARTIAL GAP price opens
lower than the previous day's close, but not lower that the previous day's low
in the case of a down gap or above the previous day's close, but not higher that
the previous day's high in the case of a gap up....I'll post some clarifying
examples shortly.
Gaps are caused by many different underlying forces including but not limited
to:
World News
Major Index component news, (i.e.. Intel warning or a buyout offer for major
index leader)
Earning's surprises, positive and negative
Dividend Announcements.
Economic pre-market reports (i.e.. unemployment, Consumer Sentiment)
Intraday Announcements, (i.e.. Surprise Fed rate cut)
AREA ( also know as Common or Pattern) gaps happen mostly in trendless markets
and close very rapidly. These are by far the most common type of gaps we run
into and while may be accompanied with bigger than normal volume, volume quickly
subsides as the gap is closed. These gaps which occur inside of consolidation
range where no new highs or lows are developed. They are the ones usually caused
by recent news and economic reports that have little "shelf-life'.
Here is an example of a daily chart where multiple gaps are created and filled
within the following weeks as a long sideways consolidation takes place. Gaps
within these consolidations are filled usually in short order. 90% will close
within 1 week with the average closing time running 6 days..
Here is an example of an hourly consolidation area chart showing multiple gaps
through the 10 day period that were all closed.
Here is a longer term daily chart showing multiple Area gaps within a
consolidation range.
Next session?....BREAKAWAY GAPS
GAPS,GAPS,GAPS...(part 3)... Today we are
going to tackle BREAKAWAY gaps.
Breakaway gaps are indications of a new trend usually occur after a breakout
from a consolidation that has been building for some period of time building up
pent up energy and demand from investors sitting on the sidelines waiting for
the "Buy" signal...(or "Sell" as the case may be). Normally we see an
accompanying surge in volume which continues for some period of time feeding on
the buying frenzy. The move, signaling the end of one trend and the beginning of
a new one, usually accompanies the breaking of a significant support or
resistance line and will most often continue in the direction of the gap for
several cycles of higher-low/higher-high stair steps (reverse for sell offs)
before any consideration of a major retracement. The reason that these are not
usually filled is that they catch most traders off-guard and their sudden move
causes them to chase the market. Many times a single news event will be the
trigger, but in reality it was a situation just waiting for an excuse.
As opposed to AREA or common gaps that close within 7 days 90+ percent of the
time, BREAKAWAY gaps show only a 1 percent closure rate in the first week. 74%
will eventually close within 1 year on upside breaks, where only 66% will close
within 1 year on downtrends...(these figures are for daily charts of
course...extrapolate for Intraday or weekly time periods.
Upside breaks, if they are going to close, will do so on average 83 days from
the breakout. Downside closures occur 86 days from breakdown.
The average number of days to the ultimate high after a breakaway to the upside
is 77 days...downside 52 days.
Average upside gains are on the order of 25% vs. downside losses of 20%
Volume levels are significant for breakaway gaps with upside volume running
between 120% and 200% of the norm for the first five days after the break.
Downside volumes can range all the way up to 260% for the same five day period.
Next session we will tackle CONTINUATION GAPS...
GAPS, GAPS GAPS-(part 4)... The next
category of gaps we will tackle are CONTINUATION gaps.
These are formed after the formation of a BREAKAWAY gap we discussed in the last
section
(If you have missed any of these gap discussions you can always go back into the
archives by clicking on the "ARCHIVES' button in the left hand column).
Here is a chart that shows two continuation gaps following a typical breakaway.
Notice that after the initial breakaway gap we formed a series of higher-high
and higher low patterns in a stair-step pattern. This is the ideal picture we
want to see coming off of a bottom, (or top if we are gapping down). It shows
that supply and demand are working efficiently within the market and buyers are
countering sellers and visa-versa, but there are more buyers than sellers on
each successive retracement.
Volume is usually high on these continuations, propelling prices in the
direction of the trend.
Continuation gaps are only closed within one week 11% of the time. The average
time for gap closure is 70 days. Continuation gaps are rarer than other pattern
types. In a recent 5 year period they only occurred 160 times in a tracked model
of 100 stocks.
They usually occur near the middle of a trend, (unlike the example we used
above). Their average gain is about half of those of breakaway gaps, so expect
about 11% up and down following the appearance of these patterns.
After a continuation gap we have a higher trend in prices peaking after an
average of 14 days of trading, (11 days for shorts)
87% of up gaps will close within 1 year while 95% of down gaps will close in the
same period.
On the day of the gap volume is usually 200% of the average volume of the
equity.
NEXT....EXHAUSTION GAPS!
GAPS, GAPS, GAPS (Part 5)...
Today we are going to discuss EXHAUSTION GAPS.
Exhaustion Gaps usually follow continuation gaps and are formed at the end of a
trend accompanied by high volume. The gap is terminal and will not be followed
by higher-highs or higher lows.
Higher than normal volume on the day of the gap will usually evidence itself in
a VERY wide gap after which prices will consolidate .
This type of gap normally closes within 1 week.
Volume can continue to spike even as prices begin to fall and normally volume
will remain high even after the gap has failed. This is indicative of investors
trying to get in at the top even as others are trying to dump their positions at
the best possible price.
While most exhaustion gaps close within 1 week, the average is 23 days for up
gaps and 17 days for down gaps.
Volumes for the next 5 days after an exhaustion gap run from 300% down to normal
seven days later for both ups and downs with the highest volume on the gap day.
These gaps will close 98% of the time within 1 year of occurrence.
The last category of gaps we will cover will be ISLAND GAPS where prices are
left stranded at highs or lows with gaps on both sides of an isolated "island"
of prices.
GAPS, GAPS, GAPS (Part 6)... .. ISLAND
GAPS
Island Gaps are actually reversal patterns which usually mark the end of a
sustained Bull run or Bearish sell off trend. The first gap looks like a
continuation gap, but when price fails to continue in the direction of the break
traders decide that the party may be over and begin to take profits or protect
positions and a second gap is formed, in the reverse direction of the first
These patterns have fairly high predictive value with 87% of Tops and 83% of
Bottom patterns proving accurate.
After an Island Top, the average decline is 21% while after a Bottom an average
rise of 34% can be anticipated.
78% of Island tops meet their predicted sell off target and 85% of Island
Bottoms meet their upside targets.
Throwbacks towards the break point occur between 65 and 75% of the time.
Volume should be high on the break day (second gap)
Island size can be from a single day (one bar reversal pattern) to several
months, although multi-day (period) islands seem to be more predictable.