Shorting The Gap
When a stock gaps down hard on heavy
volume, there’s a tendency to play the long side for the prospective short-term
bounce. But I wouldn’t try this as an intermediate-term trader looking to hold a
position for weeks to months.
In the wake of such a breakdown,
plenty of shareholders remain who regret holding on. They tend to sell into
rallies, and they tend to sell when subjected to further losses. So the likely
course for such stocks is further down in price.
Eastman Kodak
(
EK |
Quote |
Chart |
News |
PowerRating) gapped down and
fell 14 5/8 to a six-year low of 44 3/8 on volume of 16.3 million shares, nine
times its average daily trade over the past 50 sessions.Â
The market reacted to a profit warning
from the photography giant and Dow component. Eastman Kodak said its
third-quarter earnings per share would come in 20 to 25 cents below its previous
forecast of $1.56 to $1.66. The company cited weak September sales.
The stock had been trying to trade
around its 200- and 50-day moving averages. All pretense of holding near those
norms was abandoned Tuesday. And the stock cracked well below support at 55 1/2,
its intraday low on July 26 (see Point A in
above chart).
More bearish is the fact that Eastman
Kodak shares headed further south after a sharp gap-down in price and closed
near the low of the day’s trading range. The enormous volume represents
institutions abandoning the stock en masse.
This hard a decline can easily lead to
a dead-cat bounce, but the precedents signal a likelihood of further losses
after a retracement. For examples of how to short into such a scenario, see my
lesson, href=”/.site/stocks/education/patterns/05262000-6132.cfm”>Sell ‘Em
Short: Three Patterns for Bears.
For a precendent, you need look no
further than Intel
(
INTC |
Quote |
Chart |
News |
PowerRating) — a gap-down on heavy volume, a feeble rally
attempt the next day, then a quick collapse to lower lows.
All stocks, of course, are risky. In
any new trade, reduce your risk by limiting your position size and setting a
protective price stop where you will sell your new buy or cover your short in
case the market turns against you. For an introduction to combining price stops
with position sizing, see my lesson,
Risky Business. For further treatment of these and related topics,
you’ll find a mother lode of lessons in the Money
Management area of TradingMarkets’ Stocks Education section.