Wide Gap — A Sign Of Greed

Yesterday (8/1/01) after
the close,
Standard & Poor’s announced that PMC Sierra (PMCS)
will be replacing Quaker Oats (OAT)
in the S&P 500 Index after the close of trading on Thursday. This
replacement is based on the fact that PepsiCo Inc. (PEP),
one of the S&P 500 components, is buying out Quaker Oats, and this
transaction is expected to be completed on Thursday. This news, without a doubt,
will ignite PMC Sierra and may develop an interesting tradable pattern. The
chart below is a daily chart of PMCS as of the close of 8/1/01.

The stock took out its resistance
level and closed at the day’s high. Volume was heavy, nearly double its daily
average, and it appears many traders knew about the news before the close. Now
let’s see the five-minute chart from today’s session.

PMCS gapped more than 11% and
immediately traded above its 50% retracement level of the April 20 high to the
June 20 low. Needless to say, the gap was too wide. If I bought the stock
yesterday, I would not have any problems selling at the open with a more-than-11%
profit. At 9:40 a.m., PMCS fell below the 50% retracement level and declined
nearly 1 point in less than 30 minutes. Subsequently, near the end of the day
the stock managed to move above the line. (The red line is the level of the 50%
retracement.)

When the gap is too wide, it usually pays to trade against the direction of the
gap. As always, don’t forget to place stops on every trade!

Eddie

P.S.  Monthly employment data will be announced tomorrow morning. Don’t get
caught in a sudden reversal.