Traders are always searching for new tools for analyzing markets. Often times, they believe that the more complicated or exotic the indicator, the better it will work. Technical trading can take years to master. New traders can get scared away once they hear terms like “head and shoulders”, “stochastics”, “Elliot Wave”, and “Fibonacci retracement”. While many of these terms can be intimidating, it is not necessary to grasp every indicator to properly trade. Sometimes the easiest indicators are the best and most effective. One of the surest indicators is also one of the easiest to spot and learn; it’s called Gap analysis.
What’s a Gap?
A Gap is simply an unfilled space or interval. In terms of technical analysis, a gap on a price chart details an area that had no trades occur. The charts constantly show price fluctuation for a given time period. A bar indicates that a trade has occurred at a given price. When there is a difference on the chart between the old bar and the new bar, a gap has occurred. Gaps commonly occur between trading sessions, and commonly occur when a news event is released.
But What Does this Information Mean?
A gap on a chart is a giant flag sticking out in the market. It is important to notice gaps on charts because they commonly get filled. Once a market gaps higher or lower, the market will gravitate back to that price much like a magnet. This can be a powerful tool to utilize while managing or planning a trade. The beauty of this indicator is that it is easy to spot and requires very little time in analysis. Fundamental market factors for filling in a gap vary and have little relevance to the fact that the gap will commonly get filled.
A Picture is Worth a Thousand Words
Dec 11 Corn:
The chart above details the Dec11 Corn. In this example, bearish news for corn was released between the overnight trading session and the day session. The news caused the Dec11 Corn to gap lower from the overnight session. Once again, no trades occurred and the market opened roughly 26 cents lower. The chart goes on to show corn prices subsequently rose and gravitated back to filled in the prices on the chart that were unfilled.
Sep 11 Feeder Cattle:
Another example can be seen in the Sep11 Feeder Cattle. Here one can see three instances where the gaps have been filled in. The chart also shows that the gaps aren’t immediately filled in. The last gap shows that it took two months for the gap to be filled. Nonetheless, each example shows that the market will eventually gravitate back to the price point that had been unfilled.
A trader shouldn’t base his whole methodology on spotting gaps. However, gaps are easy to understand and even easier to spot. While they are just another tool with technical analysis, they are also powerful and predictable. A trader shouldn’t be compelled to trade every time he spots a gap on a chart. But by taking notice of that a gap exists, a trader can avoid pitfalls and possibly find opportunities. An indicator doesn’t have to be complicated to be effective; it just has to be used properly.
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