Fading the Gap Failing in February

Feb 5, 2008: 10:08 AM CST

It’s a new month, and the market may be off to a new character change once again. There have been three trading days in February, and so far all three days have experienced an index gap, of which only one has filled so far.

Let’s look:

There are a few things to note in this chart.

First, each blue oval represents an overnight gap in the DIA (Dow Jones ETF). Notice how the first oval was filled, but very painfully. There’s actually an argument as to how this gap was filled.

It was actually filled instantly on the first 15 minutes, then price rocketed up in the direction of the gap (as expected) but then took a hard sell again to close the gap officially (and set up a nice “Impulse Buy” retracement trend trade which achieved its target).

We’ll could that day as a “gap fill,” but if you missed that initial snap entry, odds are very high that you took a stop if you tried to fade the gap afterwards. Even though the visual trade ‘worked,’ it had to endure about $1.00 (100 Dow Points) in a stop and that was absolutely unacceptable, so actually this gap fade – with stops – failed if a trader didn’t consider the gap filled immediately (notice the long lower shadow on the first candle on February 1st).

Second, Monday’s gap which was about $0.50 (50 Dow points) actually did NOT fade, and traders would have taken a stop there as well.

Today’s gap doesn’t appear as though it will fade, and if you tried to fade it this morning, odds are extremely high you took your stop, wherever you chose to place it. Traders, remember that index gaps greater than 100 Dow points have lower odds of filling in the first place.

Third (bonus): Observe the large momentum divergence that preceded the “temporary top” formation (green diverging lines).

If this trend continues, it will be a perfect example of two things:

First: How market character and expectations change

Second: How “hot” strategies one month (that everyone figures out) become “cold” and edgeless strategies the next month

If this is a true change, then the odds may very well shift to “Fade the Gap Faders” or simply “play the gap”.

While we don’t know what will happen yet, we do expect the unexpected and know that the old adage is true in the market that:

“Whenever you finally find the key, they go and change the lock!”

Feel free to check out some videos from INO Television or their introductory overview video, which I have found extremely helpful from an educational standpoint.

1 Comment

One Response to “Fading the Gap Failing in February”

  1. JP Says:

    Yahoo Inc. fades the gap.