Gap Trading Basics - You Up For This?

Gap trading is often referred to as an easy and controlled approach to shorting and purchasing stocks. This process usually includes and individuals locating a certain stock which has price gap following a prior close, then watching the stock during the first hour of trading to figure out the trading range. A stock that rises above a certain range will signal a buy and a stock that falls below a certain range will indicate a short.

In gap trading there is simply the change in price levels between the open and close of 2 consecutive days. There are many technical manuals that define the 4 types of gap patterns as Exhaustion, Continuation, Breakaway, and Common, however, these levels are only applied following the establishment of the chart pattern. This means a gap pattern is distinguished from another gap pattern after a stock continues either down or up in some way. These patterns may be helpful in understanding long term sector and stock reactions; it may offer little help in the area of trading.

Gap Trading Strategies

For the purpose of properly trading gapping stocks, an individual should use a controlled set of exit and entry rules to lessen risk and signal trades. These strategies can be applied to intraday, end of day, or weekly gaps. Longer term investors should try to comprehend all the mechanics in gaps because something like a short can be used to sell holdings. For the purpose of trading, gap can be defined in the following areas:

1. Full Gaps
• Up (Short) -In the case where there is insufficient purchasing pressure to sustain a rise when the stock gap is up, the price of the stock will level or fall below the opening price.
• Up (Long) - if the opening price of a stock is more than the previous day’s high an individual should go back to the one minute chart past 10:30 a.m. and secure a long stop 2 bids over the high that is made in the 1st hour of trading.
• Down (Long) -There is times when bad news and poor earning will influence the price of a stock and cause it of drop uncharacteristically. A gap down happens when the gap price falls below the previous day’s low in addition to the day before that.
• Down (Short) - if the opening price of a stock is less than the previous day’s high, and individual should go back to the one minute chart past 10:30 a.m. and secure a short stop that is equal to 2 bids below the low that is made in the 1st hour of trading

2. Partial Gaps -The main difference between a Partial and Full Gap is the potential gain and risk involved. A stock that gaps entirely over the high of the previous day will have much more of a change in the market’s desire to sell or own it. When an individual enters a partial gapping stock, it will usually call for closer trailing stops of 5 to 6 percent or greater attention. The following art partial gap strategies
• Up (Short) - The short trade is the same for full gaps
• Up (Long) - The process for the long partial is the same for the full gaps
• Down (Short) - The short trade for the gap down is the same for the full down
• Down (Long) - If the opening price of fewer than the previous days close, an individual should go back to the one minute chart following 1:30 a.m. and secure a purchase stop 2 bids over the high made in the 1st hour of trading.