Have you ever looked a chart on your favorite stock or commodity and noticed a space between yesterday’s closing price and the next day’s open price? These spaces in the charts are called gaps. They happen frequently and if you know what you are doing, you can make some “easy” money.
Read on to find out a quick hack to trading the gap.
How Gaps Are Created
When trading was done in the old brick and motor exchanges, the trading day would truly end when the market closed. When trading would resume the next day, the price of the stock or commodity would start where it left off the day before. Technology now allows us to access the global financial markets anytime and anywhere. Therefore, trading is a whole new animal.
Futures markets nearly constantly in motion and the ability to trade a stock in the pre-market, post-market or even on a foreign exchange have created the opportunity for immediate reaction action to any news.
The conventional stock market hours in the United States are from 9:30am to 4pm EST. Truth is that the machines are always on somewhere and adjustments in prices have been made since the official close of business the previous day.
The Good Stuff
The often occurring price gap, or the difference from the close to open, can say a lot about market mentality.
A gap up or down of more than half a percent in the major stock indexes is not uncommon with the never ending news to move financials.
Three things can happen after the gap:
1) Price Extension – Momentum continues in the direction of the higher or lower open. Market participants with less leverage, much of move has already occurred, chase the runaway train.
2) GAP Backtrack – Price gaps are often filled…eventually. The first sixty minutes, called amateur hour, often sees emotional buying and selling that needs to be sorted out.
3) Sideways Malaise – A go nowhere market that offers little opportunity because most of the move happened on the GAP up or down open.
It is crucial to watch after that first hour of trading to see if the gap is filled or holds.
Buy the gap up with the stop loss at the previous close to capture extension, or sell into the gap strength with a stop above the day’s peak.
Don’t go try trading the gap with real money tomorrow morning. Use a practice account first and wait until you find some consistency with your performance before putting real money behind it.