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The Traders Wheel
 1/4/99 by Alan Farley

Hole-in-the-Wall

When planning new gapper trades, the Hole-in-the-Wall should be your first stop. Edwards and Magee briefly mention them in their classic Technical Analysis of Stock Trends. In the section on trend theory, they discuss an Island Reversal's important second gap. E/M refer to this move as a counter trend breakaway gap although it doesn't follow rules they provide on the subject. While the Hole can mimic a Breakaway gap, it also contains unique properties. The counter trend shock triggers predictable price movement the trader can exploit for quick swing long entries and short sales.

E/M identified gaps by their physical momentum properties and forecasting value. Breakaway, continuation and exhaustion gaps defined clear focal points of price action that were seen over and over again in dynamically trending issues. But beyond these few formations, the authors dismissed the balance of gapping throughout the market universe as having no forecasting value. This is simply not true.

While classic definitions were once adequate, their work on the subject now lacks depth for the active trader. And unfortunately, the current trade dogma asserts that everything there is to know about gaps has been written.

The forecasting value of gap behavior goes well beyond the E/M world. The study of Gap Echos alone yields tremendous new insight on entry and exit strategies. And characteristic gaps as significant as the Big Three have always existed for the trader to identify and use.

The most effective trade strategy will avoid short sales immediately following a Hole. Instead, wait for the first downdraft to complete and reverse. A quick swing long can be initiated here but expect the bounce to fail. The best short opportunity comes during the completion of this next rally. Use a Fibonacci grid to lay out the move from the short term high to the post-Hole climax low. Calculate an appropriate entry point from analysis of this grid. This rally should never complete more than 62% (allowing for "noise") of the prior downdraft before failing at least once. And the Hole should not fill without an opposite gap of similar magnitude.

mothole.gif (9036 bytes) When MOT gapped down in a 1997 Hole, the initial decline ended at a 38% Fibonacci retracement of the 4-mon trend. This popular percentage provides a powerful floor for first declines. A subsequent rally retraced almost 62% and died. Look at the typical 1-2-3 nature of the bear rally. Notice one Adam and Eve double top embedded within a smaller second one. A sharp, quick first peak followed by a more gradual lower second peak characterizes these dependable reversal patterns. If you missed your entry at the first retracement, secondary entry points appeared as Eve rolled over and the short term lows were broken.

 

Article contributed by The HARD Right Edge, which presents highly original tutorials, strategies and resources on multi-trend technical analysis and and short term trading. Article reprinted here with permission, which presents highly original tutorials, strategies and resources on multi-trend technical analysis and and short term trading. Article reprinted here with permission.
 
 

 

 
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Last modified: April 02, 2001

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