Lessons from the Pros

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Finding the Gaps

Those of you who have been in my live classes or XLT sessions know that I like to trade the morning gaps.  This is a period of high volatility and price movement and can offer great opportunities when traded properly.  Of course with the increased volatility comes greater risk and you should not trade this time unless you have a detailed plan on how to trade it that also includes risk management rules.

Gaps are caused from a large imbalance between buyers and sellers.  This imbalance could be the result of news on the company or sector or an economic data release that changes investor sentiment.  The retail traders either place orders in the after-hours markets or they have them stack up for the brokers to fill on the open.

As a trader, we can locate stocks that are likely to gap up into supply or down into demand so that we can take advantage of this novice trading.  The key is to know where to look.  One thing to remember is that even though the pre-market information may be showing a potential gap, it doesn’t mean it will happen.  There have been several times where the gap failed to materialize even after the data showed it should.

A free source for gapping information is the NASDAQ itself.  On the home page of the NASDAQ website, www.nasdaq.com, there is a section for the pre-market.  By looking at the leaders in the pre-market, we can identify which stocks may gap up or down.  Based on where the broad market is opening, this information can be used for excellent trades in the morning.

If you are looking for more options other than just the NASDAQ, then you can rely on your trading platform.  I use TradeStation which allows me to screen for gapping stocks on their radar screen.  When the market opens, the column heading “Open Gap” shows me how much a stock gapped up or down.  When I compare this to the “Net Change Open” column, I can see if that stock is trying to fill the gap.  You can populate this scanner with any list of stocks you would like and by clicking on the header; you can sort by gaps up or down.

Using another analysis technique called “Net Chg (C)” can also be useful.  This will show you the change in price from the prior day’s close and can help you to identify stocks likely to gap before they open.

Whichever method you choose to identify the stocks likely to gap, exercise caution in trading them.  Gap trading and even trading in general in the first 15 minutes of the trading day can be dangerous and should only be undertaken by experienced traders who also have a solid plan for doing so.  But once mastered, this type of trading can make for lots of profits in a short period of time.

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.