19 March 2011

Gaps : Read between the Candles

With my little knowledge of Technical Analysis (Price Volume impact on future price expectation), I have come to believe (maybe not as a rule) that Price Gaps are unsustainable.
Gaps are generally observed in spot prices daily chart, where overnight news flow, creates a trading void.

In a bear market we tend to see more gap down days and in a bull market more gap up days. As I said earlier the best thing about gaps are that they are expected to get filled in future course of time. So as an example, if Nifty gaps up 100 points at the open, with yesterday's close 5000 and today's open at 5100, we can expect Nifty to trade back to 5000 in due course of time.

An interesting observation made by chartists around the world is that, a smaller gap tends to get filled in a shorter time period and a bigger gaps are more stubborn and can initially start a larger move in its direction and get filled quite late. I have gone through a lot of charts and even done some analysis on Nifty data and have found this to be quite true. You too can do it to surprise yourself!

A wise action would be to be wary of gap ups from an investment perspective. As gaps are expected to be filled sooner than later, buying for a longer time frame at a gap up would surely result in losses, as price will surely come down to fill the gap (not to mention the time value lost). So the ideal TRADE should be (though there is never an ideal trade), to buy into a large gap and sell into a large gap down, but do the reverse in case of smaller gaps. How to identify what is large and what is small? Well for that you need to be in trading business for atleast few decades!

Just to show an example:

As you see Google came out with great quarterly numbers and the stock zoomed from 540 to 600 on opening, the mood being upbeat it rallied more for few days, but then the inevitable thing started to happen and the gap started getting filled. But hey, not completely. It started rallying again and made a higher high. Also keep checking how the volume changes. Since the 640 high, it has started correcting again and is almost back to the level where it took support earlier. But looks like this attempt to fill the gap would not go waste. This is the most updated chart, so we will have to wait to see if the hypothesis is correct.

So which gap is pending to be filled in Indian markets? The answer is very obvious, Nifty closed on 3672 on May 15th (friday) 2009 and closed on 4323 on May 18th (monday), with almost negligible trading volume. Why so? Well because the UPA has won the election, and it did not needed even the Left front to form a government!

The gap was big, 20%, and the impact was also large, Nifty though fell back close to 3900 it never filled the gap by trading close to 3672. It will be 2 years in 2 months since that event, Nifty is still north of 5000.

How many people believe we may go below 5000, I think a few (that too only after 5500 got broken and is acting as a resistance). How many people believe we may go below 4000, well I dont know any, as of now. Are we going to go below 4000, the chart surely says so.

Gaps are definitely very interesting trading phenomena, and to give you the spunk it has very close relation to human emotions involved in trading.


manu said...

happy holi..

study the gap btwn 1929-50 n dow ..nvr filled

Tarique Anwar said...

what gap are you talking about.. can you point me to the data/website?

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