Trading This "GAP UP"

I thought I would do a post on what Technical Analysts refer to as “Filling The Gap”. In a nut shell this is when  a stock will have a sudden spike in price along with an abnormal large increase in volume. Typically this occurs with a stock that has been building a base for a while (a base meaning trading in a very tight range), driven by a recent news event (or the expectation of news).

There are various types of gaps with some being up with no trades in between, some being down and some being like the chart depicted below, which is the type of gap I am going to discuss in this post and how I traded it.

This specific stock broke out in early October moving up for a couple of days, before resting then exploding to the up side with above average volume for  the next 3 days. I missed the initial run, but watched it closely waiting for an expected pull back.

Once the stock had topped out (after 3 days) it pulled back for the next two days creating a decent entry point for the expected move up which occurred and created a level of support at the first line drawn on the chart around $.23 range. This move up how ever did not break above the recent high, which was an indication the stock was going to move lower and time to exit the trade.

From my perspective money could still me made on the stock, but only as a day trade; meaning buying on the bid, selling quickly on the ask and exiting the position at the end of the day even if it meant selling a losing position.

The next point of entry to get long was the first level of support line established during the previous move off this level and proved to be a successful swing trade 3 times in a row before breaking down and once again becoming a day trade until the second line of support was reached. 

Big volume moved in and created an opportunity to go long and generate big gains, but because the stock price again failed to breach the previous high it was time to take profits and once again the stock became a day trade. 

The stock was heading to test the first line of support in the previous run and one should use a tight stop loss to avoid getting caught in a sudden break below this level.

*Note: If a stock breaks support after previously bouncing off it, it normally will not be gentle and if I get caught in this situation I will take losses on any bounce back, which often happens before the stock starts to trend lower.

Once the stock broke this support it was now a day trade, but with good volume, so decent money could be made buying and selling 25K blocks for a penny gain (that was my comfort level for position size and price gain). As the volume started to dry up and the price kept falling I put the stock on the watch list as the risk/reward was not favorable for trading.

The stock is now at the first level of support, but the volume is very light, so I am watching closely for either a big increase in volume to go long or for a big volume break down to fill the gap originally created back in early October, which again I will go long, but this in case I will be backing up the truck.

*Note: Backing up the truck means the company has good fundamentals and is not some moose pasture ;) 

A third option for this stock, which is something else I will be watching for is to start a slow grind higher, which I would not go long on, but would start trading a small position.

PS: If you think you know what stock I am talking about, please share in the comment section ... I assume some of the readers will recognize the chart right away. Also if you are watching other stocks that are developing similar patterns at the various stages of the chart, please share in the comment section as these ones are always fun to trade as long as you don't fall in love.

PPS: An analysis from  http://bioequity.org found that when a stock price gap is observed, by a chance of 91.4% it will get filled in the future. In layman’s word, 9 in 10 gaps get filled; not always, but pretty close.

*Note: There are always exceptions when it comes Technical Analysis and this applies even more  to penny stocks, which can be easily manipulated and is why many professional Technical Analysts will discount using TA with penny stocks.