One Way To Deal With Gaps

I’m having a difficult time thinking of a more disappointing day for the market in which all three major averages finished the day in the green. If you held long positions over the weekend, and then decided to sell out of them around 10:30 AM ET and go fishing, congratulations, you played it perfect.

Monday’s session confirmed the Nasdaq trading range between the evening star and the 50- and 200-day moving averages that I’ve been talking about for the last two weeks. We actually moved slightly above the March 21 evening star, but couldn’t hold that level. This could be seen as a potential double-top. You may not want to get too excited about either direction until this range is broken.  

Looking at a chart of the Nasdaq, you’ll also notice that this is the third day in a row that we have gapped up and then closed below the open.  This formation could be considered a rather odd-looking “three black crows.” Just as significant is the fact that Monday’s real red body on the candlestick chart was the largest red body since the end of January. 

I wouldn’t get too bearish and upset about this just yet. We still have moving average and price support around 1335.  Monday just confirmed that the area of resistance we expected around 1425-1430 DID act as resistance, and we are going to have to get through it before the market can start another leg higher.  The longer we stay in this trading range, the harder it will be to break out of it.  Also the longer it takes, the more significant the breakout (or breakdown) and subsequent move will likely be.

(Note: I used the Nasdaq chart in my market analysis Monday.  The S&P and Dow are in very similar shape, stuck between recent highs and the 50-day moving average.)

One lesson that can be taken from Monday is that every strategy should take into account how you are going to deal with gaps. In a case like Monday, where the market gaps up significantly in the morning and large numbers of stocks gap up with it, you should have contingency plans for making new purchases. Do not just rush right in and start buying stocks in the first five minutes of the day if they gap up significantly past your triggers.  Develop techniques to deal with these situations so you don’t end up being the person that panic buys in the morning and panic sells in the afternoon for a sizeable loss.

Here’s one way I handle it when a stock that is on my purchase list gaps significantly through its trigger:  I will wait for the stock to complete its first consolidation, and then break out from that consolidation before entering it.  Depending on the length of the charts you use, this might require you to wait for at least 10 minutes, 30 minutes, one hour, or until the afternoon.  (I normally look at 5-minute charts intraday, and will rarely enter one of these positions before 10 AM.)

Best of luck with your trading.  Feel free to email me any questions.  To those of you whom I owe emails, I fell behind the last few days, but will get back to you shortly.

Thanks,

Rob Hanna

robhanna@rcn.com

P.S.  For more information on how other TM commentators deal with gaps, check out the “Gaps” link under Trading Q&A in the TM University Section of the site.