Gaps

MetaStock SPRS Series - Week 63 - TechniTrader® Stock Discussion for MetaStock Users - Gaps - April 9, 2012
By: Martha Stokes C.M.T.

Today we are going to study the formation of Gaps, why they form, and what the gap can tell us about near term price action. As a short term trader, gaps can be either highly lucrative quick gains, or they can be devastating losses.

Most of the time, traders miss out on the quick gains of a gap. This is because they are unable to see the price and volume action that indicates a gap potential is developing. To trade gaps, you must be in the trade prior to the gap event.

Most of the time, traders fail to see the inherent risk of a reversal gap before it occurs. The risk of a gap going against you means that your stop loss could be jumped over, causing you to have a much larger loss.

Traders need to understand the mechanism and catalysts that create gaps. When you understand gaps you will be able to anticipate them better and reap the profits of riding a gap trade.

A gap is a space in the price chart that is blank. Gaps are created by pre-market open adjustments to the price of a stock or ETF.

AKAM has a chart where many gaps have formed on the downtrend and again on the bottom to uptrend.

With so many gaps, it is important to understand why gaps are forming on this particular stock.


Chart 1

First, the analysis should answer the question: What kind of gaps are forming?

1. Common Gaps
2. Breakaway Gaps
3. Running (a.k.a. measuring) Gaps
4. Exhaustion Gaps
5. Island Gaps

For AKAM these are island gaps.

Why do gaps occur?

Market Makers adjust a stock’s price prior to market open due to:

a. Heavy overnigh at market orders by smaller lots.
b. Overseas markets price syncing.
c. News event triggers heavy order flow just prior to market open.
d. HFT orders triggering sudden price jumps.

Gaps are a pre-market price adjustment. They may occur intraday as well if there is a void followed by a higher or lower bid.

Common gaps are small gaps that fill easily. These occur all the time in many stocks and are of no consequence.

Breakaway gaps are significant gaps that occur in bottoms, tops, and mid trend. These are important gaps because they often precede major trend moves and breakaways can often occur in sequential patterns, repeating the gap over and over as is shown in AKAM.

Running Gaps form midway up a trend often after a breakaway gap and, like common gaps, tend to fill easily.

Exhaustion Gaps form as the stock trend is reaching a state of speculation and price exhaustion.

Island gaps are gaps that are occurring over and over. Usually a major reversal of trend is initiated by an island gap.

AKAM has many gaps. The stock likes to gap. That means it is a news-oriented stock that generates a lot of pre-market activity. AKAM is rebounding after a significant downtrend. The upside gaps are corresponding to the downside gaps.

Each downside gap area is resistance but, as with many stocks moving out of a bottom, these resistance levels are being jumped over after a short period of platform-building.

Gaps are something every trader needs to understand in-depth. We are entering a new market condition with a full contingent of Market Participant Groups. All 9 groups are trading and investing and this means more gaps are likely.

In order to capture the big gains of a gap, you must learn to identify the platform patterns that form prior to the gap, use institutional indicators that track the institutions who move in prior to the gap and enter at that time.

Trade wisely,

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
http://technitrader.com
MetaStock Partner

©2012 Decisions Unlimited, Inc.

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