Market Loves the Gap Fade

Jan 23, 2008: 10:01 AM CST

For two days in a row now, we have seen massive gaps to the downside which have been filled rapidly to the upside, and the trauma of the morning has been erased almost instantly.

Savvy traders who employ “gap fade” tactics have potentially profited immensely from recent developments, but that does not mean these outcomes will continue indefinitely. It is, admittedly, an odd occurrence that such large gaps would occur consecutively and fill as quickly as they did. I love gap fade tactics due to their simplicity and the fact that the only indicator you need to use is price alone.

Here is the DIA (Dow Jones ETF) 1-minute chart (I do not recommend trading off the one-minute chart) which shows the instant closing nature of the gap fade.

The SPY (S&P 500 ETF) showed an almost identical patter, yet the QQQQ (NASDAQ ETF) unfortunately did not:

Traders who entered early to play long (buy) for a target of yesterday’s close were caught in a choppy environment until price began to eject as expected to the upside, granting them a maximum of a $2.00 (approximately 200 Dow Point) profit.

Recall that the target (exit) is yesterday’s high, and this can also frequently set up a trade in the direction of the original gap (in this case, enter short) to target a Fibonacci ratio or some other target that could also be the intraday price low (but that large target would have  reduced odds due to the size of the gap).

UPDATE:  1:00pm EST  The market actually did complete the two-trade gap fade where the intraday low was tested for two marvelously profitable trades.

Gaps of less than 100 Dow points have greater odds of filling, due to the fact that an opening gap greater than 100 points is a sign of a major momentum impulse which usually results in some sort of trend day off the open (Market Profile traders refer to this as the Opening Drive phenomenon).

Nevertheless, in keeping with the spirit of Mark Douglas’ teachings, “The market can do anything” and “every moment in the market is unique.”

All we can do with consistency is play the odds/probabilities as we see them and manage our risks carefully.

Trade carefully and do not panic.

1 Comment

One Response to “Market Loves the Gap Fade”

  1. MarketBeat Blog - WSJ.com : Blog Roll -- Filling Gaps Says:

    […] rapidly to the upside, and the trauma of the morning has been erased almost instantly,” he writes. “Savvy traders who employ ‘gap fade’ tactics have potentially profited immensely […]