Novice trading gaps are the ultimate picture of inexperience and faulty thinking in the market. Why are trading gaps such an important part of our education? Simple, because Novice trading gaps are the most obvious way to spot a novice market speculator. I know that doesn’t sound nice so let me say it another way. Novice trading gaps are one of the easiest ways to spot someone who is buying in a market at a price that is too expensive and selling at a price that is too cheap. If you can’t spot the novice market speculator in a market, the novice trader is probably you.
Trading gaps in price are great because, when you understand them, they are the picture of a strong supply and demand imbalance. Not every gap sends the same message or represents the same opportunity so we structure them into an understandable check list. Once this is done, we can use this information to spot the picture of novice buying or selling activity and be there to take the low risk, high reward and high probability trade.
OTA Supply/Demand Grid: 6/27/16 – XLF Novice Gap
Above is a chart of XLF. In the market that morning, before the market opened and rallied, the OTA Supply and Demand Grid suggested we may have a novice gap buying opportunity. That morning there was a gap down in the market and XLF after a decline in price, in the context of a down trend and into an area of demand. This is a clear novice trader buy signal because it represents such a huge mistake. Anyone who sells after a period of selling and at price levels where demand exceeds supply is going to lose over time, the laws of supply and demand ensure that. They may have a winning trade once in a while, but over time they will lose more often than win.
The only action worse than those two mistakes is when that person is selling a gap down, and that is what we had above with our XLF opportunity. This set up a scenario that suggested the path of least resistance for price is up, and once the market opened right into our demand level where we planned to buy, price proceeded to rally.
Let’s get back to trading gaps… In the Academy, we keep it simple. Here are some rules to keep in mind when you have a gap:
A gap up in price, into supply, after a rally in price, and in the context of a down trend is a VERY high odds shorting opportunity.
A gap up in price, not into supply, and in the context of an uptrend is a lower odds shorting opportunity and actually can be a buying opportunity on a pullback to demand when there is a significant profit zone above.
A gap down in price, into demand, after a decline in price, and in the context of an uptrend is a VERY high odds buying opportunity.
A gap down in price, not into demand, and in the context of a downtrend is a lower odds buying opportunity and may, in some cases, be a shorting opportunity after a rally into supply when there is a significant profit zone below.
While there is much more on trading gaps than I can write about in a short piece such as this one, keep in mind that the picture of the ultimate supply and demand imbalance is a gap. When you are ready to take a trade, simply ask yourself “who is on the other side of my trade” and make sure you are trading with someone who is making a big mistake according to the laws of supply and demand, motion into mass, or whatever version of this basic governing dynamic you want to call it.
Instead of looking at red and green candles on a chart and following a conventional Technical Analysis book, start looking a little deeper and begin to understand the order flow that’s going on behind the scenes that is responsible for the creation of those candles. These basic thoughts will likely give you an edge over those who are on the other side of your trades, and having that edge is the key to trading anything. If you are tired of transferring your account into someone else’s, stop looking at the market the same way everyone else does.
Hope this was helpful, have a great day.