Continued from yesterday-- the conclusion of Oliver Velez's lessons on trading gaps. For more of his tips and strategies, pick up his best-selling book Strategies for Profiting on Every Trade.
Trading Gaps, Part 2
In the last lesson, I started a discussion about gaps. I talked about what they are, how they form, and why they form.While there are many strategies involving gaps, let’s look at a few examples here.
As a rule, we like to buy strength and sell, or sell short weakness. This is the preferred play. There are exceptions. Next is an example of a stock that had a bullish pattern and looked poised to move higher (Figure 5-30). In this case, the bullishness is what sets up the short, as traders are trapped by the large gap down.
This stock gapped below an entire bullish WRB just as it looked like it was set to break out of a consolidation. While the gap makes the stock appear extended to the downside, remember this gap is a vacuum that happened when the market was closed and traders were not trading. It was likely news-driven and those long in the stock have no opportunity to get out at a favorable price. So the selling begins even after the big gap.
Figure 5-31 is an example of a long play.
Here we have a stock that has been in a bullish uptrend. Selling begins and 3 red bars appear. Two of these we would classify as WRBs. Is this the end of the up trend? The next day the stock gaps up, almost half way into the prior WRB. If this stock can hold the prior day’s low (the WRB), it is poised to move higher. The shock of the gap stops the shorts and the uptrend resumes.
Gaps come in all varieties and many of them become difficult to play. Many times the right combination of events comes together for a clear play. We look to the prior price pattern, the amount of the gap, the relative strength of the gap compared to the broader market and support and resistance, among other things. Some of the best combinations are given names as regular strategies. You should look to this list of possible combinations to find gaps that are tradable when the bigger picture is not as clear.
There are some nice things about playing gaps that many traders like. Sometimes, you can have tight stops (or can pass on the ones where you do not), and you usually get some results fairly quickly. Often, reversal time (10:00 AM) brings some results.
This is a sampling of some of the many strategies we use with gaps. This, along with the last lesson, will provide a firm foundation as you continue to expand your trading knowledge.
***For more of Oliver's tips and strategies, pick up his best-selling book Strategies for Profiting on Every Trade.