By: Martha Stokes C.M.T.
Gaps are commonplace in the modern formula automated order processing stock market. With so many market participants using orders triggered by formulas and Quantitative Analysis strategies, gaps have become more of the norm rather than the exception.
For many short term retail traders, seeing a stock gap can be a frustrating experience. You want to capture those quick points as profit, but how can you if you don’t know when or if a stock is going to gap.
Over the next few weeks we are going to discuss each type of gap and why they form, where they form, how they form, and how you can get into the stock before the gaps.
Gaps form because of overnight order flow and premarket order flow. So all gaps on the daily charts form because of what is going to happen the minute the stock market opens.
Gaps occur due to other exchanges around the world opening before the US market and trading the stock at a higher price or a lower price, than what it closed at on the US market the day before.
Gaps also form due to heavy overnight order flow where many orders come through, so the market markets legally raise the price of the stock before the stock market opens, in relation to the supply and demand ratio for that stock.
Many gaps are caused by High Frequency Trading Firms that sniff out retail news, and other events that retail traders trade on or that smaller funds trade on. The HFT trigger order reacts to the news, positive or negatively, and this starts a chain reaction of thousands of trades firing off early even before the markets open. With the HFTs buying on news or selling on news in anticipation of a smaller fund or retail market participant reaction, stocks can gap hugely at open as the supply and demand side of the market creates a heavy trading pattern.
The first step is to identify which type of gap has formed.
- Common Gap
- Breakaway Gap
- Running aka Measuring Gap
- Exhaustion Gap
- Island Continuation Gap
- Island Reversal Gap
Do you know which of the gaps listed about formed on the chart below? It is crucial to your success that you can immediately identify what gap has formed, because the type of gap tells you a great deal about what price will do next.
Once you can identify what type of gap formed, then you will be able to determine what price will do next.
KORS is a young IPO stock, it has only been a listed stock since December of 2011. The recent gap is significant. Do you know what this most recent gap is from the list above?
Please study this stock and all the gaps on its chart. Next week we will discuss this type of gap, why it gapped, and how you could have anticipated this gap, getting in early before the stock moves several points. Also we will discuss whether this gap will “fill” or whether it will continue upward.
Hint: this one is the type of gap that seldom fills and tends to move upward.
Martha Stokes, C.M.T.
Member of Market Technicians Association
Master Rated Technical Analyst: Decisions Unlimited, Inc.
Instructor and Developer of TechniTrader® Stock Market Courses
©2012 Decisions Unlimited, Inc.
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