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The Morning Gap, Part 3

Tue, Aug 19 2008, 06:26 GMT
by Online Trading Academy Team

Online Trading Academy

I have written articles in the past entitled: "The Morning Gap,  Part 1 and  Part 2 ". Last week's morning gaps in the equity markets provided very low risk, high reward, and high probability opportunity but only if you understand the difference between quality support (demand) and resistance (supply) and non-quality support and resistance. Understand that the words support and resistance have different meanings for many people.
For some, Fibonacci levels are support and resistance. For others, moving averages are what they count on as support and resistance. And others, pivot lows and highs or clusters of candles on a chart are what they look for. Let's take a deeper look into this topic and combine it with the opportunities that opening gaps provide.

Here we have a chart of the S&P futures including some days from last week. Area "A" on the chart is what some people would call a support (demand) level and sometimes, price does turn at these levels (not often).
Notice at "B", the S&P opens right into this support level and falls through it like a hot knife through butter.
This is because area "A" is not the quality support level we are looking for, at least not in the XLT. One of the reasons it is not quality is because it is in the middle of a move. That sideways trading range is preceded by a rally in price and followed by a rally in price meaning it's in the middle of a move. Now let's take a look at area "C". This is a pivot low and represents the higher quality demand (support) we are looking for. Notice how price explodes out of that pivot low. This can only happen because at "C", demand greatly exceeds supply. At "D", we were in the XLT going over the potential opportunity with the gap down into demand (support). Someone mentioned that it may be high risk to buy a gap down at "D". My question would be, "who is selling on that gap down"? Is it a consistently profitable trader or not? When we focus on the action of the seller at "D", we know that they are selling AFTER a decline in price and INTO a price level where demand exceeds supply. A consistently profitable trader would never do that, they would not be consistently profitable. The laws of supply and demand ensure that the trader who consistently takes that novice action will consistently lose over time. They may have a winner here and there but over time will lose. Therefore, we want to be sitting at "D", ready to buy from that novice seller on the gap open. If we are wrong, it's a small loss as the risk is low. The two red lines you see on the chart were our targets as they represented price levels where we may have some supply. The lower target was the origin of the gap and the higher target is the nearest pivot high.

Planning out all your trades based on simple and objective market logic allows you to get paid from those who don't. Understand the difference between quality and non-quality support (demand) and resistance (supply) and then think about who is on the other side of your trade. That combination can make you a powerful morning gap trader with some practice.

Note: Our long dollar, short British Pound and Euro position trades are doing well. While I would expect the dollar to strengthen much more against these two currencies, now is not the time to enter into these positions if you are not already in. That low risk / high reward opportunity was weeks ago when it was suggested. The dollar is nearing some supply (resistance) and the Pound and Euro are nearing some demand (support) which is where we could see a bounce. As this plays out, there will be more opportunities to enter these positions if you are not already in them. Look for updates here.

Published on  Tue, Aug 19 2008, 06:29 GMT