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A lot of traders fear overnight gaps. A gap is when the price jumps one way or the other overnight compared to the closing price of the day before. Sure, if you are in the wrong way and a market gaps against you it hurts somewhat. But if you are in the right way then they are easy money. As David Bowden said, there is nothing sweeter than overnight money. Looking at the profit or loss they provide is one thing; however for the savvy technical trader gaps provide tremendous value.
Macquarie Group (MQG) is a major player in the make-up of the ASX200 index and over recent weeks has taken quite a fall in the share price. How could a technical trader have used the ‘resistance’ that a gap down provides to profit from a short trade on this stock?
Chart 1 is the daily bar chart of the newly coded MQG. As you can see I have boxed in the region representing the gap down when the share price dropped heavily after the close of February 5, 2008. The close of that day was $67.16 and represents the true top of the gap according to the teachings of W.D. Gann and David Bowden.
Chart 1 – Macquarie Group (MQG) Daily Bar Chart
click chart for more detail
Recently the share price rallied from the March lows to the top on May 19 and then subsequently dropped more than $15.00 per share. That’s a great short trade in anyone’s language; it represents a drop of around 20% of the share price in a couple of weeks.
The high on May 19 was $67.20, which was achieved soon after open. The closing price on the day was $66.10. Some would say ‘that meant the gap was closed’ even if you consider the top of the gap to be at the close of February 5 ($67.16). However I don’t consider the gap ‘sealed’ or closed until it can at least close above the $67.16 which the stock failed to do. You could consider this a false break on closing the gap.
There were additional ‘time’ reasons to also watch this date for a change in trend and the failure to ‘seal’ the gap only added conviction to the potential for a short trading opportunity around this time. The gap provided resistance on an important date and to the street smart trader therein lays an opportunity.
This little gem of an example came up on our Safety in the Market forum in a discussion on exactly what constitutes a gap being closed. Had the gap in question been closed, then chances were that the stock price was going to go much higher. Now on the downside you will see where I have pointed out two ‘gap ups’ that would need to be filled (and sealed) before you would not get overly bearish on the MQG share price.
My recommendation to all budding technical traders is learn to appreciate the value that gaps provide in terms of future market direction through their support and resistance. Learn not to fear gaps, but to embrace them, as they can make you a great deal of money once fully understood and appreciated.
Until next time, good trading…
Noel Campbell
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