Market Fades an Incredible Gap

I wanted to post the amazing gap fade that took place earlier today:

The morning started with a large volatility (150 Dow point) gap as the economic news was very bearish this morning (oil and gold at new record highs, signaling inflation, and a larger than expected drop in retail sales).

The market, however, shook off this news and frustrated traders who exited, and punished those who got short this morning.

Although the first impulse is to fade an overnight gap, two factors prevented this classic play this morning:

  1. The gap was greater than a 100 point Dow gap, meaning odds favored continuation rather than a filling of the gap
  2. The market did continue in the direction of the gap almost 100 points down, which would have taken out virtually any stop you placed if you tried to fade this gap

A momentum divergence formed as price made a new swing low on the day (in fact, it was a significant momentum divergence – see green arrow). Price then began a massive upside move that actually formed the ‘pole’ of a developing flag-style pattern.

A 45 degree angle pullback into 1:00pm formed the actual flag portion, and set-up a long (buy) trade in the direction of the impulse (note the new momentum high just after 11:00am).

The “measured move” or price target of the flag is being reached currently, which would have resulted in a highly successful trade if you were ambitious enough to ‘fade the news’ and play the price pattern alone. Sometimes it is best to strive to be a technical purist, for that was where the money was made today.

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