Always Mind The Gap

by | Apr 26, 2020 | blog, Editorial | 0 comments

There are hundreds, possibly thousands of technical indicators used to try to decipher the trend and momentum of the markets.

However, most of them are just noise, and totally worthless!

In fact, the only thing you need to remember is the first rule of trading:

Always “mind the gap” over everything else!

Why is that?  

That’s because a gap is caused by an event that forces traders to jump in. 

These traders are both longer-term and speculative looking for quick profits and are buying and selling stocks as fast as possible

Sound intimidating? It shouldn’t! As long as you learn how to correctly trade the gap, you can make money in any direction… 

And with these simple steps, even you will have the confidence to take advantage of this wild price action

That’s why I’m going to give you two methods you can apply to profit off gaps.

Why should you take the time to study this?

Because they happen all the time and can be extremely profitable when you know how to trade them.

 

What Is A Gap

 

A gap is an area on a chart where there is no trading activity taking place.  Typically gaps normally occur between the close of the market and the next day’s open.  

There are many different types of gaps, but generally speaking, there are only gap up and gap down.

 

Source: Thinkorswim

 

You can see all of the gaps the SPY has each and every day.

Generally speaking, gaps are only found around periods of news or earnings that drive the price away from the prior days close.  For example, if a company had a great earnings report compared with last quarter, the company’s stock might trade higher in the post and pre markets.

Gaps result from extraordinary buying or selling interest developing while the market is closed.

Gaps can offer evidence that something important has happened to the fundamentals or the psychology of the traders that accompanies this large movement. 

 

What Does Gap up and Gap Down Mean?

 

  1. A gap up means that the price of the stock opens higher than the previous close
  2. A gap down means that the price of the stock opens lower than the previous close

 

Types of Gaps

 

Gaps can be broken down into two basic categories:

  • Gap and Go
  • Gap and Fade

Let’s take a look at those and see how we can predict the way the markets are heading.

 

Gap and Go

 

A “gap and go” strategy is a pattern that is formed when a stock is very strong (or weak) and the price action supports the direction of the trade right from the open of the day.

Typically when trading a Gap and Go strategy, the SPY will give you a heads up to what the day is going to do ahead of time.

In order to get a jump start on the day, you’d want to look at the premarket trading session for signs of a strong or weak market.  

When looking at the momentum for the trading day ahead, you want to be sure to follow the pre-market momentum strategy to get on the right side of the trade.

 

Source: Thinkorswim

 

In this example, there are 4 key indicators that signaled there was going to be a strong market for the trading day at the open.

The pre-market momentum indicators:

  • The overall trend of the premarket was positive and pointing to higher prices
  • The 10 period MA > 20 period MA, showing continued strength in short term trading
  • Early in the pre-market, there was a breakout of the TTM squeeze pattern and prices were being pushed higher with increasing momentum
  • Momentum was building during a small pullback at 9:30am signaling the selloff was a fake-out and prices were going to continue higher

Pro Tip:  Be careful trading aggressively when you’re missing any of the key components from my premarket momentum analysis or the stock could be a Gap and Fade instead of a Gap and Go.  

 

Gap and Fade

 

Gap and Fade is a very popular strategy for day traders that are looking to take advantage of market psychology that states that all gaps must be filled or at least tested.  

Now, this doesn’t mean that all gaps are going to be filled, but it does mean that the likelihood of a gap being filled is very high.

Gap and Fades are a popular alternative to the Gap and Go, especially when the premarket trading session doesn’t have every pre-market momentum indicator showing a strong open.

Here is an example of mixed signals coming from the pre-market momentum indicators.

 

Source: Thinkorswim

 

Looking at the pre and post-market sessions, the markets are not showing any clear direction that they are planning to take for the trading day ahead.

To summarize:  

  • In post-market, the 10 MA < 20 MA showing weakness
  • In the pre-market, the 10 MA > 20 MA showing strength
  • Going into the open, the TTM squeeze and momentum are showing a weakening market

It’s best to be careful on Gap and Fade strategies.  As you approach the prior day’s close, the markets could reverse suddenly and cause you to take significant losses on your trade.  

If you were not paying close attention to the trade right at the open above, the markets reversed right at the day prior close and continued higher throughout the remainder of the day.

 

Wrapping Up

 

So before you rush out and trade the open, it’s a great idea to correctly analyze the gap to get you on the right side of the trade.

Some gaps are useful for day trading while other gaps are great for determining major swings in the stock markets.  

But with a quick and simple gap analysis strategy, it’s possible that you are able to get a jump on the markets and pick up a trade just by minding the gap.

If you’re hungry to learn more then I encourage you to take my masterclass, for a limited time you can join it for free.

 

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