Gathering Cash with Trading Gaps

Gap trading strategies are some of the simplest trading techniques behind basic technical chart patterns and candlestick readings. With nothing more than a candlestick chart, a professional watching the markets can get a glimpse into the market and make trades based on the market action that happens between each candle or bar.

Gap Trading Strategies

Gap trading strategies are based mostly on market momentum. Following a gap, traders are able to seize the current momentum and ride the wave until profits are taken. There are a few ways to gauge which gaps indicate a buy or a sell and which mean virtually nothing.

First and foremost, gap trading strategies should never be used in illiquid markets or those with low volume. If you've ever glanced at a chart of a low volume stock or other security, you know right away that these charts have hundreds, if not thousands, of gaps in a period of days or weeks. (If you haven't seen this effect, try looking up a chart of Berkshire Hathaway A shares).

The goal with gap trading strategies is to find gaps that matter, not just gaps. What makes most gaps powerful indicators is that they are rare, and that they actually signify something about the market. Finding a gap in the chart of an illiquid stock is like trying to find the right needle in a stack of needles. How are you to know which needle, or which gap, is the one you're looking for?

Volume Based Gap Trading Strategies

Gap trading strategies almost always rely on the relationship between the gap and the amount of volume that precedes or follows the gap in price.

When a gap up or down occurs in the price, traders should immediately look for an accompanying increase in volume. If volume trends higher, this shows one of two things: that a large trader is exiting the market at the gap price, or that a large buyer is entering the market at the gap price.

A stock or security that gaps above a resistance line should be purchased immediately, as the price is now supported on the other side of the trend at your current entry price. A stock that gaps below a support line should be sold, since no further downside protection exists until the next support.

Typically, moves through trendlines that are the result of gaps maintain stronger momentum than those that are completed in a careful and slow slide through the trendline. Be sure that following each gap, a horizontal support and resistance line is drawn, as a number of orders are usually waiting for the next touch to the chart gap.

Profit Taking

Since momentum can reverse at any time, and it can be either extremely strong or disgustingly weak, gap trading strategies usually call for the use of a trailing stop to take profits. This way, you'll be automatically exited from a position at the first sight of reversal, locking in profits before the strength of a single gap is dwarfed by market action.

Gap traders have to be fast acting and able to scan for gaps as they happen. Frequently, after a gap appears, traders have all but the time it takes to complete two to three bars before the majority of the movement is complete. After that time, the best of the profit potential has already been harvested.
Tim Ord
Ord Oracle

Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...
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