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.
