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Waking up with the market opening with a gap can be anxious and stressful for some and an opportunity for others. Gaps are a shock to the rhythm of the market due to recent news. The only way to adjust the imbalance is result of a gap. There are many types of gaps and many ways to trade the gaps. Many books and courses discuss this phenomenon extensively, explaining the what, the why, and the how. Technical analytic approach to gap works best because it simplifies the phenomenon to make it easier to understand: identifying support and resistance in these gap structures. In short, simplicity trading is trading with success. Categorizing them can be beneficial if they can answer two logical questions: will the gap fill? And if yes, where is the threshold level to determining that the market is filling the gap? Gaps happen when an imbalance of demand and supply, causing prices to spike one way or the other to meet the satisfaction of other side who are willing to come into the market and take the transaction. These spike areas are pockets of empty volume and this must be remembered because volume drives prices and without volume prices will not move. It’s common that the price areas where high volume are seen, the gap top and bottom areas become areas of support and resistance, meaning if these prices happen to show up again, expect same congestion due to same high volume (same market players entering or exiting the market) from the previous occasion. One special characteristic about gaps is that the buildup was so tremendous force creating this gap, that it requires same or more force to keep it going in the same direction. If not, where no follow-through is in sight (i.e. no volume or no movement of prices away from the gap area), a gap fill may soon occur. This process will play itself out very quickly in a few hours within the open. The above chart shows a gap that is quickly reinforced in the same direction. It quickly moves away from the gap area with good volume and pushed prices higher. It only pulled back to confirm the breakout using the top gap as support before continuing to move upward. Whenever the prices break into the gap, very often it will fill it completely. Why? Because the gap has little or no volume so there is only a small number of buyers or sellers who have previous commitments in this area. This make the fill happen very quickly. Unless the market is very strong in the direction of the gap that it somehow goes midway into the gap and reverse or there is a resistance/support area created before the gap took place. In this case, many buyers or sellers have major commitments and it may cause an interruption to the gap fill as shown in the example below. The bar that pierces the gap now looks more likely the gap will be filled. Unfortunately, the resistance in the middle of the gap stood out and stopped the rally dead in its track. It later reversed back to the gap bottom. One way to watch whether or not the gap will be filled is volume. Lack of commitment after the gap shows the direction might not hold up. Without new players coming to strengthen to push the trend further, the gap will most likely to be filled. The chart below immediately after the big fat red bar (high volume bar in Equivolume chart), volume immediately dried up (note small thin bars). One bar after another, the prices did not pierce the gap bar's low, making the bears nervous and bulls more confident that the gap may fill today. Professionals love fading gaps against inexperienced excited traders who trade based on news. Staying calm and trying to understand price action in charts can help decipher what may happen next. Volume is crucial in determining the gap action: reverse and fill or continue the original direction. Gaps provide one of the most reliable setups with price stop and targets already determined immediately after they are formed, establishing normally a very favorable risk/reward ratio. ---------- This article was first submitted and posted at MrSwing.com. More trading articles. Charts provided SwingTracker

very nice, Raul. I'm following your thread so keep posting.

Been trading for 5 years and still learning. Slower learner and getting somewhere I think. Once a newbie always a newbie. Why? I still make mistakes, always new mistakes to be made, always something about myself that still needs perfecting, and of course, the market always teach new things everyday. There's always som ewhere new to learn and never stop learning.

Ah! Not only do you know your trading, you know your wine as well, especially little-known but wonderful Spanish red wine! Bravo! I'll make sure you'll get a taste of nice priorato and rioja alta (best wine area from Rioja appellation).

Excellent post! The quest for the Holy Grail is no more than journey of self-discovery. Pure and simple. After this, trading systems, strategies, indicators, and markets will all make sense.

no problem. you have my blessing.

I didn't write it but not too difficult. It was taken from Alexander Elder's book "Trading for a living." Best way to explain it is showing the formula itself: Volume * (Close - Close[1]) This is similar to momentum indicator except it adds volume as an equal importance. Basically, the difference of the close of yesterday (or bar) and the close of today multiply by today's volume (interchange day to bar or vice versa). So the movement of the price with that volume tells how much impact volume had in moving price bar to bar. The bigger the movement, the higher reading the indicator will show, provided the volume remains the same. If the close stagnates, the indicators will show a small reading. The divergence happens when either volume dries up while the price is moving in a steady pace or price difference was miniscule while volume remains the same. So from the previous chart I showed, prices reached the same level, but volume was diminishing. Or that the prices are stagnating producing more bars than necessary to form that 2nd bottom while volume remain the same. What can we infer from that? Lots of volume couldn't push prices further down for the 2nd hypothesis. The answer to 1st hypothesis is that prices was being pushed down by low volume. These 2 answers usually match with the common TA knowledge regarding volume. I find the volume bars on the bottom of the chart very difficult to read, and volume average line doesn't help much either. Using force index averages out the volume and identifies divergence much easier. Hope I explained it as well as Elder did (I don't have the book in front of me so had to use my own interpretation of it).

My entry ahead of time is dynamic in a sense that I place the buy stop to wait for the momentum to go my way, letting the market take me in. This way, I hitching a ride in the bus that's going my way... uptown, downtown. I wouldn't want to get in the bus going an opposite direction and hold the driver at gunpoint and order him to turn around, trouble will be brewing sooner or later. But lots of traders do just that.

I guess this one of the reasons why it's a difficult adjustment for floor traders to electronic traders like us. Without seeing the human interactions and body language and only charts, this is something new to them to get used to. You also bring up something very interesting. The big pockets usually the ones that can take you of the game. I read a trading book or article (this the above article) somewhere that make a comparison to poker that the odds of making it also depends on your funds level. The probability of smaller players will get wiped out is much higher. So in all, the average investor has very little chance of survival? So is card reading more important than player reading?

Yes, no need to search for it. I'm attaching it here. It might need a better place in this forum though. FORCE-INDEX.ELD

Excellent article! I have a few questions about the tactics. 5 Varying your bets. One of the most powerful tools in any game is the ability to change your bet when you have an edge. This is true for blackjack, poker, and trading. You don’t start a new strategy with 5,000 shares; you work up to bigger trade size. I understand this might very important in poker. I haven't really used this method as I've backtested with the same size. Although there are tools out there, position-sizing skews statistics on probability of your strategy because it doesn't determine when your strategy is at its trading best. Only after a while do you know in what condition and situation your strategy is best can you size it up. 6 Betting for information. In poker, a small bet is sometimes used to gain information about your opponent’s hand. In trading, you may use a small trade to gain information about the presence of buyers or sellers. With both games, using that information is key to your eventual success. I've actually heard some traders do this, putting a small position to determine if there is bid or ask out there to see where the buyers and sellers are. I don't use this myself since charts with volume already showed where they are likely to be at (ie. S/R). 2 Number of outs. The more ways you have to make a hand, the greater your probability of successes. In trading, the more ways you have to hedge a trade, the more outs you have, and the greater your chances of success. I'm not sure about #2. I don't understand what this mean. Anyone can explain this point? Any input on this or any other points from this article. It's a fascinating article.

I usually identify breakout or failure from S/R areas and wait for the first pullback or rally to buy or short. To place the trade ahead of time, I place a buy stop (for longs) a few ticks higher than the last bar's high. As it moves down, I adjust the buy stop accordingly until the stop is hit. The opposite is true with shorts.

Excellent! Too bad I'm not to there to ask tons of questions:D

I pointed out in the chat room was a double-bottom breakout early in the morning and confirmed on ER2. Target is 771. After that, no idea. You can see from this chart also there was a bullish divergence on Force Index made on the 2nd bottom. Price is king and volume is queen! Long live the king and queen!

I've never played much poker, but there is a social poker club I've been thinking of joining. I may learn a thing or two that might enhance my trading? But card reading can't be transfered to trading?!

So can the opposite be true? A good trader becomes a good poker player?!

Hi feb, excellent idea since we didn't cover it today. I can be there first hour only tomorrow. In addition to myself, some will not be there or we cannot come to agreement, I suggest someone be responsible to save the transcript or text.

Nice post, ez. I remember I used to trade the scanned stocks: whatever the scan comes up for the day, 5-20 at the opening. That was stressful. Couldn't take it after a few months (losses to add to the story). After a while, I decided to get smart and stressless by just concentrate on one instrument and watch it like a hawk for a few hours and during those few hours, make the most of what's given and profit from there. Now at times it can be boring because nothing is happening. If I'm bored, it tells me to stay away from touching the buy/sell button. Bored but certainly not stressful. Others may disagree but trading is like driving, if you get to your destination bored, that means you survived the journey, else you arrived stressed out, chances are you've come close to involving in a collision or worst. Stress makes the worst mental state to trade. But then again so is boredom. Choose your poison. Mine is the latter, one difference is that this state help me concentrate and trade better.

I use both stop loss and profit target. I move my stop incrementally toward my profit target until my target is reached, whichever comes first. This way, I keep my profits but also giving the market room to reach my target.

RIGHT ON, TERRY!

Market has been going up full steam without much retracement (greed setting in?). I see a rising wedge so it's sign of unhealthy run-up. BUT... cannot call it that either until market proves itself that it's doing what it's doing first before committing money to counter-trend trading.

It's so simple, people think there has to be more to it than that. In the end, it is simple but getting to that simplicity point of view takes time. Simple eh?

Yes, charting tools are from TS (check View->Toolbars->Drawing). Yes I take positions in 1 swoop and exit in one swoop. It's still tough sometimes to hold oneself back from not exiting when watching the retracements. But I've come to realize 2 things: 1) money is made and then some from sitting on winners to cover the many losers. 2) these retracements indicate that the trend is healthy, giving new players a chance to come in and push the trend further. 3) Many times I realize I always take my profits too early no matter how much I think the market has gone already; this is a bias I'm still trying to get rid of. Of course psychologically it's tough to watch prices go against your position but a couple of things I did that helped me overcome them. Once the trade was in my favor, I put the stop at breakeven. Once I had the position risk-free, it became easier to let the position go its way and only to move the stop to add more profits. The other thing I overcame was the initial stop loss; I had to accept that will be the loss I personally accept already, no matter the outcome of the trade. Knowing this makes me more careful about taking a position and avoid overtrading. So if it goes against me, so be it. This comes from confidence but confidence from letting go is from knowing your strategy will work and that takes lots of practice, time and patience to see for yourself that the strategy work (backtesting and papertrading). I took one year to papertrade before I was confident enough to trade it and accept the loss on each trade I make. From this period I improved my stats that 1 out of 2 trade is a loser so that fact made me comfortable about taking the loss because I know the trades I take are carefully selected for the high probability trades. Having confidence in your system is the first hurdle. The last hurdle is patience to let the winner take its course. That is why exiting takes a long time to master because patience is the last trade virtue a trader learns and masters. Just IMHO.

CNBC is Comedy Central LOL! Freudian slip it may be but many ways similarities are uncanny. These "comedians" make us laugh with their "recommedations" one after another and they are out on the line trying to forecast and predict. Worst, the hot fund managers make their money on fees, not from their stock pick wizardry. I prefer to see floor traders whose livelihood depends on their trading. Charts tell me more quickly and honestly than some talking head tooting their own horns and their picks. I used to avidly watched their shows that result in losses before I turned it off and turned a profit. My opinions of their performance was in some ways linked to my past performance: recommendations don't work without your own homework involved. Sorry, back to the question at hand, the rules were set for most. Some started trade without knowing the rules but this is what free enterprise is: as long as you don't break the rules, the world is yours if you can outsmart your competitor to get customers to your door. Some chose to be ignorant and trade until ruin while others go slowly and learn all the rules then trade to become profitable. Most of us chose the ignorant way (I included) but everyone is accountable for their actions to participate or not and their way in participating. So conscience shouldn't exist because the rule applies to everyone and ignorance is no excuse (as cops like to remind infractors of this). I paid my dues.

I wonder how the floor traders do day after day, moving markets with $millions. Do they sit out too if they don't feel like trading? And if they have to trade for their clients even if they're not up to it? I'd love to hear from a pro who works or used to work on the floor. I guess a book written by one would do.