KLCI took a beating last week as a result of most stock prices succumbed to series of bad news. We have seen China reporting its largest traded deficit in 7 years in February, crude oil price continuing its ascent due to growing unrest in Libya, contraction in Japan's 4Q2010 GDP, Moody's downgrade of Spain's government bonds rating, and also not forgetting the unfortunate natural calamity that hit Japan last Friday.
While all these adversely affect regional stock market, we as distinguished traders/investors know well that stock prices are now retreating to possible lows. For those who have lost a fortune last week, reflect on your losses, then wipe your tears right now! Opportunities tend to show itself during unexpectedly bad situations! Remember,
"From the ashes of defeat, burns the fire to success!"
INTRODUCTION
In Part 1, we have discussed on the basic strategies that most traders practise, which could be summarized as follows:
- "Go (trade) in the direction of Window" (Window as Continuation Pattern)
- Empty vacuum as Support & Resistance, confirmed by volume (Gap Breakout Play)
COMMON GAP (CG)
As the name suggests, CGs are commonly seen on charts. They often appear on shorter time frame charts, such as 1 and 5 minute charts, but may also appear on daily charts in numerous occassions. CG happened due to short temporary differences in pricing psychology, which don't really play a significant influence on the price trend.
Therefore, CGs usually appear together with low volume confirmation, and the vacuum area would be relatively smaller compared to other types of Gaps. Traders will expect that CGs would be filled rather quickly, perhaps within a few minutes (intra-day chart) or days (daily chart), before continuing the prevalent trend.
BREAKAWAY GAP (BG)
BG usually appears in two situations where:
- A prevalent trend has been established, and the stock price has been moving along the trend, and hesitated at the top or the bottom.
- The prevalent trend has ended, and the stock price has moved into a consolidation in a box range.
Traders will generally wait for the break to extend for a moment and will expect the stock price to make a retracement back to the Gap Support or Resistance. Only then, they will buy, or short stocks accordingly.
In KLSE, the probability of a downtrend BG to make a pull back to its resistance is a lot lower compared to an uptrend BG. This is because this retracement happens due to profit takings. As KLSE discourages shorting of stocks (policy wise), and if a downtrend BG were to occur, those caught in the wrong position will frantically sell to cut loss. This action will further increase the already strong downward force! Dumb Money (DM), in this sense, will start cannibalizing among themselves. >.<
RUNAWAY GAP (RG)
RG appears in the middle of an trend. Sometimes RG is called a Continuation Gap, which literally means a continuation of prevalent trend. A RG normally comes together with a huge volume and an empty vacuum usually smaller than BG, but bigger than a CG.
RG occurs due to renewed interests in the stock. This may happen following a reported increase/decrease in corporate earnings during a price uptrend/downtrend. Investors' confidence are greatly enhanced/reduced by this, causing the eventual Gap Up/Down.
EXHAUSTION GAP (EG)
EG usually shows itself at the end of the prevalent trend. EG comes with a small volume, and has a huge empty vacuum. The term "Exhaustion" here means that the prevalent trend is over-extended, and is currently exhausted. The trend has come to an end.
Having said so, traders should expect to see a sharp trend reversal after the new high/low is hit.
PUTTING IT ALL TOGETHER
Let's study AFFIN's chart between late October 2009 to mid April 2010.
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Illustration (i) : Playing the Gap - AFFIN |
At A, a Common Gap is seen, which has a small empty vacuum in between accompanied by low volume. It has an insignificant effect on the trend, and was therefore instinctively filled on the next day.
At B, we could see a Runaway Gap. Although the empty vacuum is small, the gap is formed after an uptrend is established. In addition to that, the volume that come together with the gap is not massive enough to be considered as a Breakaway Gap.
After two days, an Exhaustion Gap is seen at C. This is evidenced by a significantly massive volume, pushing the stock price up to a ridiculous high, causing the trend to over-extend. A very useful indicator to use while detecting overextended trends is the Bollinger Band. You can see that the White Candle at C is trading outside the Upper Bollinger Band, which is a very strong evidence that the trend had over-extended, which you would then expect a trend reversal to follow.
Soon, the price kissed the Gap Support twice, and then made a bounce to test the prior resistance made by the high at C. Failing to break through the resistance up north (as expected), the price then made its way south to break the Gap Support.
The supposedly downward trending technical outlook took a complete turn when the candles made a Breakaway Gap at D. This is a Breakaway Gap due to the high volume which accompanied the Gap Up. With the Gap unlikely to fill itself, the price went all the way up from mid December 2009 to mid April 2010, when the price again over-extended itself when it formed a White Candle outside of the Upper Bollinger Band.
Assuming that you took a long position after the Breakaway Gap on 14/12, and closed your position just after the confirmation on 12/04, you would have made a 31.3% profit in just a little under 4 months, which is already well above the average performance of most, if not all, mutual funds in Malaysia. All these profits could have been yours, if you have been competently playing well with the Gap. ^_^
CONCLUSION
The Window classifications made by Western traders are very useful indication of whether the Gap will fill itself or otherwise in near future, thereby allowing traders to position themselves for better entries. Below table shows a summary of the four Gaps.
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Illustration (ii) : Summary - Type of Gaps |
There is saying like this among Western Traders, "Gaps will be filled". Basing on this belief, many traders go against the Gap, hoping the Gap will be filled. Well, I have no idea how true this saying is. But as far as I'm concerned, I play the Gaps professionally, according to the strategies I've detailed above. I may not win all the time, but the probability of winning is greatly enhanced, and that's what Technical Analysis all about. :D
tlsinvestor.blogspot.com prays for the unfortunate victims of recent earthquake and tsunami in Japan. I urge all readers to join us for a moment of silence right now... May the streak of calamities end soon...
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