MAILBAG QUESTION:

"...regarding you comments of last week you describe that a recent gap day in spx was bullish. what can I predict from gaps? they are not something I notice much except if it was a bullish or bearish day."

MY RESPONSE:

PRICE GAPS IN FORECASTING PRICE MOVES:

Price gaps on daily or hourly charts are created when an Index or a Stock trades ABOVE the prior trading day's High, creating an upside price 'gap'; a downside price 'gap' is where a day's price range is BELOW the Low of the prior session. Gaps are created when there's space or a gap between one day's price range (OHLC) and the next. Gaps come about from news and events occurring outside of normal U.S. trading hours; e.g., news that is construed as bullish or bearish occurs from a report released after, or before, Market hours.

You may have noticed numerous price gaps in commodity or commodity futures' charts. Gaps are not as common in the stock market (in the major indices) or quite as much in individual stocks. Gap 'events' can be useful in forecasting new, or further, price swings because such gaps take on more forecasting 'meaning' so to speak.

Different kinds of gaps, with different descriptive names, are involved when occurring: 1.) in the apparent early stages of a move (a breakaway gap), in 2.) what appears to be in the middle of a move (a measuring gap), or 3.) a gap up or down in what could be at or near the end of a move (an exhaustion gap).

'BREAKAWAY' GAPS:

When a major market index has been trending lower, or higher, for some time, often also associated with an oversold or overbought condition and then appears to REVERSE to the upside or downside, an early related pattern is an upside or downside price gap as new bullish or bearish influences come into play.

An upside or downside gap early in a new directional move adds weight to the idea that a NEW trend is underway. This is why the term 'breakaway' is used, as in making a 'break' in a new direction.

Another characteristic of price gaps is that the LOW end of an upside gap tends to 'act as' support and the HIGH end of a downside gap tends to act as resistance. This is the one reason that there's the saying that gaps often get 'filled in'; e.g., a subsequent pullback to the low end of an upside gap tends to see buying support come in and prices hold this line. However, breakaway price gaps that suggest a new trend is underway often see a chart gap space stay OPEN for the duration of the move that's gotten underway.

The S&P 500 (SPX) daily chart is seen below with highlights of prior recent price gaps. Note that first upside (breakaway) gap seen after SPX fell to the low end of its broad uptrend channel (and got oversold - not shown here), was an ALERT to a significant trend change as market participants turned bullish. The subsequent pullback (from the 1897 peak) retraced a 'nominal' 50% of the prior advance and then turned higher. An upside (breakaway) soon occurred.

'MEASURING GAPS':

The so-called measuring gap highlighted below in SPX is a further upside gap after the rally has been underway for awhile and is often associated with an approximate mid-point of the overall upswing. The 'measuring' implications of such a second gap being about half way in an overall price move doesn't always pan out but it's not uncommon either.

The Nasdaq Composite (COMP) has many, but not all, of the same price gaps as the foregoing SPX chart. The second upside gap (left side of chart below), labeled as a 'measuring gap' is approximately, not exactly, around the mid-point of the strong February-March advance.

'EXHAUSTION GAPS':

The TOP most upside gap seen on the left of the COMP daily chart below is known as an 'exhaustion' type gap. This type of gap occurs after a move has been underway for some time. In this example, bullish sentiment has gotten extreme and traders/investors are falling all over themselves to bid prices higher. Greed we could say is way in the ascendant. It's said that this situation leads to 'exhaustion' of so much bullish enthusiasm. Overnight bullish news has finally led to a much bigger upside price gap the following trading day. This type of gap, as traders/investors throw money at stocks, suggests that the trend is vulnerable to a reversal. When prices weaken, there is often heavy profit taking and a sharp pullback can follow.

The most recent sizable upside price gap in COMP, again highlighted as a 'possible measuring gap' could well be around the middle or mid-point of the current advance ASSUMING the Nas Composite advances back to the area of its prior high in the 4365-4370 area. This looks like a possibility, especially given that the big cap Nasdaq 100, NDX (not shown) has already run up to ITS prior top. Stay tuned on that!



Individual stocks can have more numerous upside and downside price gaps than the broad indices, which tend to 'smooth out' the sharper price swings that a Dow bellwether stock like General Electric (GE) is prone to.

ISLAND BOTTOMS/ISLAND TOPS:

On the lower left on GE's daily chart below is a formation called an island bottom. This is a complex pattern consisting of a downside ('exhaustion' type) price gap, followed by a sideways consolidation, followed by an upside 'breakaway' type) price gap at the end of the consolidation. This price action leaves an isolated formation resembling an (isolated) 'island'. The reverse pattern is an 'island top' and it's usually reliable bottom or top pattern.

The next gap was another upside breakaway type gap (there can be more than one), followed later, after a pullback, by a 'measuring' type gap that is about half way between the upside breakaway gap (the one AFTER the island bottom) and its top at 28.

The accelerating downside move early this year (2014) led to a DOWNSIDE breakaway gap in GE.

Note that the support/buying interest at the LOW end of the last upside gap has been an area of support/buying interest in the stock, which goes back to my point that the LOW end of upside price gaps often define or 'act as' support on subsequent pullbacks.

MONTHLY CHART REVIEW :

I often have found that traders don't usually or often look at monthly charts. Why would they if, for example, they are trading just the 2-3 day or 2-3 week price swings. Where a month is a LONG time already! However looking at weekly and monthly charts keeps the MAJOR trend in perspective and I like to show the monthly chart occasionally, often to remind myself of the DOMINANT price trend or the big picture within which the smaller trading cycles occur.

I also like to, at the same time, remind myself of how overbought or oversold the Market is by use of, for example, a 13-month Relative Strength Index.

MONTHLY S&P 500 (SPX):

While the May SPX Close at 1923.57 has only gained 4/10th (.04%) of a percent relative to the December 2013 Close, the pattern year-to-date continues the strong multiyear uptrend.

However, SPX has been hitting minor resistance implied by the upper end of the Index's monthly uptrend price channel as highlighted below. Moreover, SPX is at an 'overbought' extreme on a long-term (13-month) basis. The two technical factors together suggest corresponding potential for a significant top at some point ahead. Complacency in maintaining ONLY a bullish investment or trading posture, come what may, could be risky.

The Nasdaq Composite (COMP), on a monthly chart basis, is showing congestion/resistance at the upper trendline. If COMP trades sideways for time and builds a support base in the 4000 area, it could rebound to 4500 but longer-term upside potential would seem greater IF there was a deeper pullback, such as even back to the 3500 area. That would likely get many to ALL bearish on the tech-heavy Nasdaq but could also 'set up' a next advance in a continued long-term bull market.

The past 6-month sideways move could also be seen a possible bull flag suggesting eventual upside potential, on a bullish breakout above 4300, to 5000.


GOOD TRADING SUCCESS!