Option Investor
Trader's Corner

Taking Measurements

Printer friendly version

Wouldn't you like to know when a trending was about halfway completed? If you're lucky enough, a certain kind of gap will tell you just that.

Annotated Daily Chart of JNPR:

According to Thomas A. Meyers, writing in THE TECHNICAN ANALYSIS COURSE, measuring gaps are also known as runaway gaps or continuation gaps. They tend to occur about in the middle of a fast-moving up or downtrend. They illustrate strong momentum. Although strong volume is sometimes seen on a measuring gap, it's not a necessary confirmation.

These gaps are not found as frequently as other types of gaps, such as the breakaway gaps studied in last week's article, but they're easily distinguishable. They come after a trend has been established rather than at the beginning of a trend.

Like the breakaway gaps discussed last week, they may not be filled until the trend has completed and prices have reversed. That may be long after the gap was created. Meyers considers them reliable tools for measuring the probable targets of trends, but he offers a caution: they occur when prices have dropped about halfway through their eventual percentage drop, not halfway through the actual price drop.

What does that mean? Let's look at the JNPR example. The peak at the left-hand side of the chart was at $27.29. The trough was at $12.60. From peak to trough, JNPR lost 53.8 percent of its value. Half of that peak-to-trough percentage loss occurred when JNPR had lost 26.9 percent of its value at the peak, so at $27.29 x 0.269 = $19.95. That does appear to be approximately halfway through the gap.

In practical means, though, especially on long-term movements, Meyers says that to properly gauge the eventual target, you should be studying a semi-log chart and not an arithmetic one. If you're looking at an arithmetic chart and measuring vertical distances, Meyers cautions, you might misinterpret how much more of the move is yet to occur. If prices are in a downtrend, as JNPR was, the portion of the drop after the gap will be smaller than the portion of the drop before it on an arithmetic chart. In an uptrend, the opposite would be true.

Let's look at that chart of JNPR again on a semi-log scale.

Annotated Daily Chart of JNPR:

In this particular case, the distance as measured on an arithmetic chart was actually a better measure of the vertical distance that JNPR would travel.

Annotated Daily Chart of JNPR:

In practice, it's probably best to keep in mind that a runaway or measuring gap tends to come about halfway through the percentage move, perhaps not relying too heavily on vertical measurements on either type of chart, as good as they might be for providing a quick estimate of where prices might go.

Since runaway or measuring gaps tend to be rare but are often reliable measures, attention should be paid when one occurs. For example, we saw one produced on Citigroup's (C) chart in late October.

Annotated Daily Chart of Citigroup:

This chart was snapped after the close on February 1, as this article was prepared. What was it suggesting then? If that gap was a runaway or measuring gap, it was suggesting that C had met and even exceeded the downside target suggested by that gap. Traders who had measured vertical distances or calculated percentages would have been alerted to snug up their stops on bearish positions as C approached the zone from about $22.00-26.00 that C was approaching a possible downside target and bounce point.

Does it mean that C's troubles are over and it's time to buy? Some certainly thought so and that may be true for the short or even intermediate term. However, this measuring gap signaled where the intermediate move might end only, not where the long-term one would. Care must still be exercised.

Sometimes more than one runaway gap occurs in a strong trend. When that happens, the gaps tend to lose their measuring capacities, and subsequent gaps after the first runaway or measuring gap should always be suspected of being exhaustion gaps. Those types of gaps will be covered in the next article.

Trader's Corner Archives