Another Reason To Pay Attention To Gaps
I’m still not excited about the market and
believe continued caution in warranted. The Nasdaq has continued to lag over the
last two days. On top of that the VIX hit it lowest level in a long time and could
get stretched to the downside very soon.
Today I’d like to look at an example of a trade whose risk/reward ratio
was vastly improved due to the fact that the stock gapped lower overnight. The
stock is BYH. The chart below is as of last night…
src=”https://tradingmarkets.com/media/2003/Hanna/rh121703-01.gif” />
On December 1, BYH which is a Chinese stock (hot region) in the Chemicals-Plastics
Industry Group (hot industry) broke out of a 5-week consolidation on big volume.
It then had a quick 30% run-up before pulling back sharply the last few days.
Yesterday the selloff seemed to reverse just above the 50% fib retracement of
the 11/20-12/15 upswing. Last night the stock was set-up as a Connors’
TradingWindow. The trigger coming into the morning was around $15.20 ($0.10
above yesterday’s high). The problem was that to place a stop below yesterday’s
low would have been risking $1.35 (almost 9%). Even if the trade was successful,
the distance from the trigger to the recent high was only $1.20. So while the
setup was valid, the risk reward ratio wasn’t very good…until this
morning.
src=”https://tradingmarkets.com/media/2003/Hanna/rh121703-02.gif” />
This morning BYH gapped down just below yesterday’s low, but still above
the 50% Fib Retracement. It traded in a $0.02 range for the first 5 minutes,
and then moved up through yesterday’s low shortly after. At this point,
a “Gap Windows†entry could have been used and the initial risk
could have been $0.05 to $0.15 — a very tight stop (either low of day
or Fib level could have been used). Once triggered the trade never looked back.
Within 10 minutes a portion of the trade could have been taken off as the small
initial risk was already covered.
src=”https://tradingmarkets.com/media/2003/Hanna/rh121703-03.gif” />
The stock has not yet fully re-asserted its uptrend, and who knows what will
happen from here? Many traders may notice it tonight as a potential trade for
tomorrow. (Still looks like it has potential.) Those paying close attention
could have entered today and already have a “breakeven-at-worstâ€
(barring another gap down) position should it decide to follow through.
Many times gaps can create gift entries or exits for positions. Pay attention
to how your list of potential trading candidates opens and you will more easily
spot and be able to take advantage of gaps.
Good Trading,
Rob Hanna
robhanna@rcn.com