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The Traders Wheel
6/20/98 by Alan Farley

Morning Gap Downs

For years, it terrified me to place a buy order into a big NASDAQ morning gap down. Then one day, it just stopped scaring me and got a whole lot easier. The turning point was being trapped on the other side.

I had tried to exit a big DELL position thinking it was 3:01pm. Unfortunately, I lost an hour somewhere and it was really 4:01pm. The markets were closed and I was stuck with the largest overnight position of my trading career. Sleep did not come easily as ugly scenarios flashed through my brain. Sure enough, the next morning DELL was set to open 3 points below the close. I’ll never forget the pain in my stomach watching that spread drop before the open. As rational knowledge of the numbers receded, fear-driven instinct took over. In total shock I sold into the open, just happy to be relieved of the pain.

Immediately the stock went straight up like a rocket, well past the prior close.

Market insiders use fear to generate profits. When conditions favor strong buying interest, stomach-churning gaps may be low risk trades. Correctly interpreting this market sentiment prepares you to capitalize on misinformed sellers. But caution is advised: if you lack trading experience, avoid gap down entries. Taking a position at the wrong time can be very deadly to your equity account.

You need to have confidence in your numbers and understand the market crowd. Seasoned traders recognize many redundant features in these morning setups. Market makers are not particularly original in their strategies and will continue to play the same games as often as they can get away with them.

For example, many insiders missed last week’s big tech rally but still wanted to get on board cheap. A CPQ loss and an analyst comment on INTC set the stage. Since many traders already expected a reversal, market makers played on their strong fears and knocked down the opening bids. But CPQ was already near a multiyear low and INTC had traded a strong breakout rally just the day before. Add to that the continuing rise of the semiconductors and conditions were ripe for buyers (and insiders) to catch the falling INTC knife.

The best trading opportunities come when the majority lean the wrong way. But don’t try to play the gap down for a home run. This trade sets up because a strong uptrend precedes the gap and new buyers should appear to reassert the larger bull move. But a shock decline is a countertrend (bear) impulse in the next shorter time frame and this can trigger a dangerous Hole in the Wall or Island Reversal price pattern on the intraday chart. So smart traders will take their quick profits and move on.

 

intc5min.gif (7803 bytes) INTC offered a classic low risk gap down trade on 6/17. The author entered a limit order for 57 � just two minutes before opening and sold at 58 1/8 about 1/2 hour later. Using technical analysis, 57 stood out as an important support number: the breakout point of the prior rally, the top of the breakout gap, the 50 day moving average and 100% retracement of the last rally wave.

 

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