A Few Ways To Trade Gaps…
The market traded
sideways most of the day today before selling off over the last hour
and a half going into the close. Volume was once again light. The story
remains the same. I’m seeing a good amount of potential in stocks that are
setting up, but the market is still lacking any conviction. Individual stocks
are mostly seeing weak follow-through and the indices can’t rally for more than
a couple of days. The VIX remains at very low levels but is not stretched from
it’s 10-day moving average at all. I would stick to only the best setups and
keep it light until more conviction is seen.
Today I thought I would review
some of my thoughts regarding gaps. When a stock gaps out of a base and moves
higher it can be one of the most reliable types of breakouts. An unfilled gap
shows exceptional strength. Many times a gap is created due to good news on the
company. If the news truly is good (such as earnings-related news) many times
the stock will continue to attract investors and will trend higher over the
following weeks and months.
The problem one encounters when
looking to buy gaps is that it can be a risky proposition. The larger the gap,
the farther away potential price supports will be. Also, the tendency for many
stocks is to fill their gaps before moving higher creates a dilemma. (The
strongest stocks never fill their breakout gaps.) To minimize risk, I suggest
traders let the stock either 1)consolidate and then break out on an intraday
chart, or 2) pull back and reverse, before purchasing. This can create a
lower-risk entry than buying near the open or chasing a quick run-up in the
first few minutes of trading.
Kaydon Corp (KDN) is a member
of the strong Metal processing/fabrication group. Friday morning it gapped out
of a base with a high of $29.18. It reached it’s high within the first 5
minutes of trading and then began to sell off. It closed it gap later that
morning and then traded sideways for the rest of the day, finishing right near
the base high.
^next^
Rather than buying near the opening gap, a lower-risk entry
for KDN would have been to buy the reversal today after the gap had filled.
Axcan Parmaceutical is another example from today.
Here again you would have been better off waiting for the
gap to fill and reverse before buying.
As I mentioned earlier, many of the best breakout gaps
never fill. In that case, buying the breakout of the first consolidation with a
stop below that consolidation can provide a lower-risk entry. Amedisys (AMED)
provided an example of this type of entry today.
After gapping just above the handle of $29.20, AMED quickly ran to $30 before
pulling back and consolidating. It was the breakout above $30 just after 10
o’clock that could have triggered a lower risk entry.
Just as important as buying
stocks that have solid return potential is making sure you control your risk
when purchasing them. Rather than blindly buying gaps, take some time determine
a strategy that could provide you a lower risk entry.
Best of luck with your trading,