Traders are always asking me about how to view the gaps and what are the trading opportunities associated with them. Well, I’m not going to give away all the secrets in an online article, you have to attend one of Online Trading Academy’s courses or the Extended Learning Track to discover them, (collective sigh of relief from all students). However, I will share one thing to watch as you are looking at whether the gaps will fill quickly.
Gaps are caused by imbalances between buyers and sellers. If there are no sellers and an overwhelming amount of buyers want into a stock, they will be forced to raise their bid to the area where there are sellers so they can satisfy their demand. The reverse is true when sellers overwhelm the buyers. This often occurs when there is news on a company or the markets. In our classes, we also teach that a trader should center their decision to buy or sell based on the price in relation to supply and demand. Combining gaps with the supply and demand knowledge offers a powerful price direction indicator.
Looking at the intraday chart of Infosys, we can see that price opened at a demand zone from the day before. The large amount of selling pressure that caused the price to open lower was immediately absorbed by the buying pressure at demand. A trader watching this would have been able to capitalize on the quick rise in price.
It is important to check and see if price is gapping into demand or just below it. If price had gapped below the demand zone, the gap would have been less likely to fill and a price drop would have likely ensued.
The opposite reaction occurs if price gaps into, but not past a supply level. Looking at the daily chart of Hindalco, you can see the failed attempt from the buyers who chased price into the supply zone. The gap into the supply zone was a signal of weakness.
The smart trader would have noticed that the price simply gapped up to prior supply and the sellers waiting there easily absorbed the buying pressure of the amateurs and sent prices lower. Be sure to pay attention to where price gaps into and practice good risk management. Do not take positions prior to the announcements and do not let your emotions get the better of you and jump into a stock before it hits a reversal point. Until next time, trade safe!