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11.14.2020 - Free Investing Newsletter click here! Bookmark

The annoying Gap

 

 One of my pet peeves when it comes to all things market, is the morning gap up or gap down. If you’ve been around the markets long enough, you know a few things that are indeed true. For instance, if you’re not “in” the market on the 10 best market days, there’s a chance you’re flat on the year.

 

Well this is also true concerning gap up mornings. If you’re not in the market at the close the day before, it’s frustrating as hell to see the market gap higher by 100 or 200 points the next day, and worse…. Many is the time that the morning gap high, is the high of the entire day.

 

This is what catches so many new traders off guard. They see the morning futures suggesting a big open and they put in market orders at the open. Well those market makers see all those market orders, and they line them up on the “wheel.”  Then they can literally ‘place” your order pretty much where they want.

 

So, what happens is that the market gaps up say 150 points. You have a market order for XYZ on the open. Those Market makers see the volume and since it’s their job to make as much as possible, they will try and fill you at the highest price point they can. Let’s say XYZ gapped from a close of 95.50 last night, and opens at 96.75.

 

If you look at enough gap up opens, the market generally gaps up big, jams higher for just a moment or two, then dips as daytraders take their quick profits. Then it usually bounces, making an even bigger high in those first couple moments. THAT’s where they want to fill your market order.  

 

They see “all” the orders. So what they do is they fill the “limit” orders first, and ‘save” your order for a bit. Then on that double high, they fill you out. From there on, it’s market mechanics as to where the day is going to go, and quite often, the high of the first 20 minutes IS THE HIGH OF THE DAY. Meaning that if you sent in a market order in the premarket before you left for work, they probably filled you at an ugly high price. By 10:30 you’re likely to be underwater. Ouch.

 

The key to gap opens, is to be IN the stock and reap the benefits of the gap. Consider the following “facts”

 

On Oct 30, the DOW closed at 26,501.  The next day it opened at 26,691.  That’s 190 points. The market didn’t do that “organically” by millions of traders buying and selling, the market got there from the futures market suggesting it should be higher and “boom” higher it went. If you weren’t in it, you didn’t get it.  But that was okay, because the market did go higher intra day, you just missed the gap money.

 

That went on for 4 sessions, with gaps of 100 to 300 points. But then “it” happened. On Nov 6, we closed at 28,323. The next day we gapped and boy did we gap. We opened at 29,467. Yes, over 1200 points.

 

The people that owned it the day before, made out like bandits. And that’s my point. When the market is heading higher, a Tremendous amount of the gains comes at the hands of gap ups. Not intra day trading.

 

The obvious problem with this, is that markets gap DOWN too. On Oct 23, we closed at 28,335. The next day we opened at 28,185.  That’s a loss of  150 points. If you were in the DOW overnight, there’s NOTHING you could have done to prevent losing money. 

 

The next day we closed at 27,463. The following morning we opened at 27,102.  That means 361  points simply “vanished” from the close one day, to the open the next. There’s no defense against that. You can’t sell your stocks at 2 am when they’re playing games with the futures market.

 

This is why I’m so against gap opens. Frankly I believe they should be illegal. How is it fair that I can go to bed with my stock XYZ closing at 101.45  and the very next morning in the open  of premarket trading, it’s down 4 bucks? It’s not fair, it’s criminal. But then, so is Wall Street, so take it for what it’s worth.

 

If I had a point behind all this, it is that If you bought every open this year and sold at the close you’d be DOWN on the year. Yes read it again. However,  If you bought every close, and sold in the morning, you’d be UP big on the year. Sounds upside down, no? Indeed.

 

So what’s the defense? How do we get around all that? First off, you can’t completely. It’s simply a fact that gaps are here and they’re here to stay. Your best defense if you’re a long only player is the morning wait game.

 

As I said, quite often the first 20 minutes to about 40 minutes is the high of the day for the market. Look at the intra day action for virtually any stock you’d like and then average it out over 22 days (which is the average amount of trading days in a month) and you’ll see that more times than not that opening high, is the high of the day.

 

So, we like to ignore that morning slop. Now, here’s where it gets sort of interesting. If you’re a daytrader, with a good platform and the time to sit there and watch things, you can play both sides of this. You can often short the opening fifteen minutes, bail out, then play the upside bounce  if it develops.

 

But what if you just want a safe entry on a stock you’re going to hold for a bit. Well, in that case, even today after 28 years of watching things, the “safest’ entry is to mark the stocks high between 9:31 am and about 10:10.  Let’s say that’s 56.22. Then it fades off that and for hours it’s trading around 55.90 – 56.04.

 

Then, at about 2 pm, you see it start moving and it crosses over that morning high of 56.22. That’s when you pull the trigger. Why? Well, you know that it didn’t get there on overnight market maker shenanigans. It got there because during the day, more people were buying it than selling it. It was “organic” as we like to say.

 

The other thing it “proves” is this: When the morning high is set, where it ran out of upside gas is now a resistance point. If during the day the buying pressure is so great that it exceeds that resistance level, it’s another sign that the organic buying pressure is pretty positive.

 

Does this always work? Heck no. NOTHING and you can repeat that a thousand times, nothing always works in the market. But to this day, it still seems to be the safest entry I’ve been able to discern.

 

One thing that we’ve done successfully lately in all this volatility, has been on red closes, to buy a bit of a high flyer like NVDA at that close. Then reap the 2, 3, 5 dollars on the morning gap up that’s been so common lately. We did it Thursday at the close, buying the XLK.

 

We bought at the close on Thursday  at 120.18. Then Friday morning it opened at 121.09, ripped to 120.30 in moments and then faded. We sold it at 120.20 grabbing that quick dollar per share.

 

Trading is not easy, but if you can find a trend, you can often tilt the odds in your favor. But no matter what, I’ll always hate gaps.  Have a great weekend.

 

 

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