A gap on a daily chart where there is no
trading activity between 2 consecutive trading days is what I called a true
gap. From my experience, a true gap is absolutely powerful and it is what
institutional traders pay attention to when they initiate a trade. Below is an
example of a true gap:
A gap, as Japanese traders call it “window”, can act as
support/resistance level on a chart. However, we can tell if some gaps are
stronger than others by its location on the chart and volume. There are many types of gaps which you can
learn more HERE.
The fact is you don’t even have to know all of them to trade effectively. Only
thing you need to remember is “gap up becomes support area and gap down becomes
resistance area”. Take a look at gap up and gap down on DVAX chart below:
When we have a gap (up or down) the whole gap becomes
support/resistance zone. With gap up, the whole gap becomes support zone with
major support level on the lower line. And vice versa for the gap down, the
whole gap becomes resistance zone with major resistance level on the upper
line. So what I like to do when I see gap on a chart is draw 2 lines (like DVAX
chart above), then I know if I have support/resistance level near my entry or
not. Many traders don’t really pay attention
to this (even a 2cents gap still can be resistance/support level), so they
would buy just below the gap and have a stock turns on them the next couple of
days. What I like to do when I have a good setup but a gap is just above my
entry, I would wait for the gap to fill and break on daily chart and try to get
in the next day.
Sometimes you will see a stock stalling for a few days right
at the gap. This is the time when the market is in indecision mode and you
(beginner) shouldn’t be trying to guess which way it’s going to go (although
there are ways to predict breakouts which I will go over in another lesson). Your
job here is to watch the price action and go with the momentum; either go long
on a breakout or short on a breakdown with stop loss in place.
Normally a high volume gap should be stronger than a low
volume one, giving that the chart is not too overextended. A high volume gap
that occurs on an overextended chart can indicate a buying/selling climax which
results in change of trend (instead of continuation). So it is very important
to look for both volume and location of the gap before placing a trade. Also
note that some stocks might have a lot of gaps on the chart (once every few
days); in that case you can/should ignore the gaps.
If you have any questions, please leave your
comment below or contact me directly by email.
