Gaps

[lovemoney]

I've been reading up on gaps. I read about the three main types of gaps and generally where and why they might happen. But I'm not really getting why alot of traders feel a gap 'must' be filled. Read something else about if a gap never fills then people aren't sure if a trend is really ended or something to that effect. But I don't get that. What exactly are the consequences if a gap never gets filled?

Saw somewhere that someone said that's actually a myth and that it's not technically true that they must be filled, but that generally traders "abhor" gaps. They hate them in other words. Why? And why do people want them to be filled?

[Doc Holliday]

there are no consequences to any technical indicator that fails except that the equity may move in a different direction that you believed. I don't think anyone could say that any technical indicator MUST do anything but the odds are better that the market will follow a pattern. If you look at a few stock charts with gaps in them, more often than not they do get filled IMHO. I believe that a more accurate statement would be that the market abhors a gap much like nature abhors a vacuum. Traders tend to use gaps just like any other indicator..as a signal ;)

[lovemoney]

Thanks Doc for your reply! That helps me some. But I guess that's also where I'm llost, because I'm not exactly seeing how a gap is a failure of an indicator. I understand your vacum example but, I don't see how a gap will cause a trader to think something else might happen down the road other than what they might have believed, if still following all the other indicators as normal.

The best way I can illustrate my confusion would as follows.

Say, I'm going down the highway at a good cruising speed of 60 MPH or whatever, and I come up over a steep hill and for about 1 or 2 seconds my car goes airborn and misses about 3 feet of pavement but comes down and resumes normally on it's way, I'm not going to worry about that 3 feet of pavement where my tires didn't meet the concrete because I'm still going to go down the road to my destination no differently than if I'd stayed completely earth bound as I went over that hill.

That's how I look at a gap at this point, considering I don't know enough about them.

I get confused when I hear someone look at a chart and say, "oh today it closed that gap that appeared a month and a half ago, so now the stock should do this or that."

I guess in my mind I'm thinking,"what difference does it make"?

I'm a beginner, so I ask alot of questions when I'm trying to learn and not grasping something that I read up on or heard somebody say. Hope you all will bear with me. Thanks much for your help

[fatbacker]

Normally when there is a type of gap either up or down there will usually be at some time a type of correction in the stock. Just like any over or undervalued stock. The best thing to do when encountering a gap is to check out the behind the scenes issues to see if you can figure out why a gap was created. They could come from a bad PR, missing a target price, exceeding a target price and/or something extraordinarily good or bad happened.

After a gap has happened there are usually trends and supports that will form to give you an indicator if the gap may fill.

Learning what trend lines are and finding out what breakout plays are you can find tons of examples of gaps and figure out the trends to see if and when and how the gap filled.

There are lots of reasons for gaps and looking at financials and news reports are usually great for finding out why.

[Doc Holliday]

But I guess that's also where I'm llost, because I'm not exactly seeing how a gap is a failure of an indicator.

no no, failing to fill a gap is a failure of that gap as an indicator. I do look at gaps and some examples of it can be seen on ONT...it gapped up, came back down to fill the gap and is now moving back up. If I had the money, I'd have bought into it when it filled the gap and would have made some nice green since and in the future.
SPAR will show you an example of a gap that didn't fill. I don't think that it is going to go back down and fill it now so I missed a good entry point on it by waiting for it to go down when it just kept climbing upward

[lovemoney]

Originally Posted by fatbacker

Normally when there is a type of gap either up or down there will usually be at some time a type of correction in the stock. Just like any over or undervalued stock. The best thing to do when encountering a gap is to check out the behind the scenes issues to see if you can figure out why a gap was created. They could come from a bad PR, missing a target price, exceeding a target price and/or something extraordinarily good or bad happened.

So, it kind of sounds like you're saying that a gap is sort of an 'overeaction' to something regarding that security, and that there's a chance it may sooner or later retrace itself in a way to compensate for that overeaction (but not necessarily garranteed) because the gap sort of threw everything into a different level or plane than where it would have normally been, be it higher or lower. Am I sort of grasping it in the right way now?

ie: if a breakaway gap shoots up in price and continues for a while, then at some point in time that security may drop back down in price to a lower level than expected to correct that false area it has been in sinse the gap ocurred.

Is that kind of in the ballpark?

[fatbacker]

That is pretty close to correct, but as I have said it is always wise to do your DD(Due Dillagence). There is usually a reason that you can find out through SEC filings or PR's due to some product or possible lawsuit. Just the fact that you check other sources to find out why.

Learning what trend lines are and keeping a close eye on those will tell you whether or not you should enter into a stock or average down if you got stuck in a possible gap down. Also when you see a large gap up do not get to excited and buy in assuming it will keep going up. I have been and many other have been trapped in a gap and trap type situation. It is where a stock has very nice run and looks to have a nice gap up then tanks as the day goes on. That happens alot in OTCBB stocks.

[lovemoney]

Thanks guys, I really appreciate it. I think I have a little better understanding of the gap and what it's about now.

[Skydaemon]

I think of it kind of like this. Note this is not the official reason behind this at all, it's just how I view it. A gap that occurs leaves a bunch of preferred trades (buys or sells depending) in it's wake that won't occur.

If a gap is sizable, most of those traders will just buckle down and convince themselves that someday the price will come back where they like it, and they just stop participating and wait for it to do so. I think of it like a range of bitter traders I guess you could say ;)

Anyway, leaving people behind like thins the volume marginally due to non participation and leaves a range of trades where people are pining away for, if the stock ever returns even briefly to that range it'll likely get stuck filling the whole range of bitter traders orders as they jump all over it, which can stick the price there for a good portion of a day, possibly long enough to re-establish it as the price for following trading.

So basically gaps are "sticky" regions that basically trap a price should it ever wander near it again. Surely you've seen a stock where one day, it just had a weird trade or something that plummeted the price right into the carpet, but then the stock carried on as if that never happened. Well stocks with gaps don't necessarily come back.

That doesn't mean that it's a sure thing, traders will hold on for a couple years waiting sometimes, traders that missed the boat can be _really_ stubborn, but eventually they do give up. Also, it's possible that there weren't many trades waiting to happen in that range anyway, especially in a thinly traded stock, a gap doesn't necessarily mean anything.

So I view the likelihood of gaps mattering as relative to the expectation people would've had to be able to trade there. I see it as more likely on heavily traded stocks where traders got blindsided and didn't see the gap coming.

I also believe this is why you see MMs who are changing a price do that staircase pattern. You know the one, where it drops like a penny every day and they hold it and absorb all the trades till the trades die off then they drop it another cent and so on all week or two. I think they do that because they know they can't make the new price stick unless they kill off the bitter traders so there are no sticky regions above them. If they do that they can make the new price stick at the new level they want.

[lovemoney]

Thanks, Skydaemon. I agree the significance seems to really come down to the expectaions of the traders I guess and how they want to react to it. I do understand also, what everyone's said about how it may affect the trend afterwards and to be watchful.