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Let's talk about gap downs for a minute here, because we want
everyone to be clear about how we deal with them here. Let's suppose
we wake up and the futures are in the toilet. We "know" it's going
to be a horrid open, so sure enough the bell rings and down we go.
How do you play it? How do you play the bounce? This is what we do:
If the market feels really lousy, we will hop on some fast short
plays, but we also know that very few gap downs simply gap down and
then fall forever. No, we usually gap down, fall some more, and then
see a bounce.
What we like to do is watch the "open prices" on the stocks we are
targeting for a bounce. Let's suppose we think that XYZ is probably
ready to move higher, but it's being gapped down and pressured by
the overall selling. Well, since we really never know how far down a
gap/sell is going to take us, trying to pick the bottom of the fall
is dangerous, "oversold" can get more "oversolder" if you get our
drift.
So, what we do is we watch where the stock "gap down opens". Let's
say XYZ had closed the night before at 34.50 and it's going to open
today at 33 because the futures are down 50 points. Okay, so it
opens at 33, and soon it's down to 32.20 and then it pauses. Should
you jump in? Maybe, but what we find much safer is waiting for it to
cross back over that opening 33 level. Many times a gap down/sell
will bounce, but it doesn't take out the opening price. That's a bad
sign and often indicates the stock os going to roll over and sell
some more.
But, let's say it opens at 33, falls to 32.25 and now it's moving
back up. We often will take a shot at it a few cents above it's
opening price, say at 33.10 or 33.20 or so. Why? Because the
technical traders will look at that gap down open as a "resistance"
level that has to be broken before it's safe to go long. By waiting
for the stock to cross it's opening price, they often breathe a sigh
of relief and will tell their trading desks that the first
resistance is cleared and the stock is clear to trade at least to
the previous day's close.
Very often we see a big gap down, bounce back, and then the stock
ends the day pretty close to the close of the day before the big gap
down. If you take note of the opening price, and then time your
trade to get in on the bounce when it crosses it, there is about a
65% chance it will climb back to the previous evenings close.
So, don't try and bottom fish the exact bottom on a gap down, it's
much safer to just wait and see if it can clear the opening price
hurdle. More times than not if it can, it's got a really good shot
at moving up to the previous days close, and often that is a dollar
or even two dollars higher. A pretty good trade no mater how you add
it up!
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