Trading Stocks Using Price Gaps

By: Scott Cole Click author's name for more of his/her articles

Learning how to exploit price gaps can greatly improve the bottom line of the daytrader. Daytraders who can learn how to employ this simple indicator will add a significant weapon to their arsenal.

So what is a price gap? An upside gap occurs when the opening price is above the previous day's high price. A downside gap occurs when the opening price is below previous day's lowest price. Now, we can get into discussing a variety of these gaps, whether they are breakaway gaps, gap failures, continuation gaps, etc. However, as daytraders, these do not concern us. We only need to know how to react when we see a gap occur at the start of the trading day.

In fact, one of the first things a daytrader should do after the stock market opens is formulate a last of stocks that have gapped open. If the overall stock market is weak and opens lower, the daytrader should compile a list of stocks opening significantly weaker, and vice versa if the market opens to the upside and has been strong. And THEN, the trader should compile a list of stocks gapping in the direction OPPOSITE the overall market.

For instance, if the market opens flat or to the downside, any stock that gaps significantly higher is probably going to continue trading in that direction for the rest of the day. This is particularly the case if the stock breaks out of a consolidation pattern. Usually, this type of occurrence happens when a company announces earnings, or something new with its business.

Most trading platforms will all you to do this directly, or indirectly. Stocks making new 52 week highs or lows can be screened for as well, and then analyzed further to determine those that have gap openings. Once you have compiled your list of stocks with opening gaps narrow them down to those that are up or down the greatest percentage.

Now it is time to let the stocks prove themselves. If a stock gaps higher, we want to see that stock continue moving in the direction of its gap, and then we will be confident that it will continue in that direction for the rest of the trading day. The same is true if the stock opens to the downside.

A good strategy to use to enter a trade then is the opening range breakout. There are a couple ways to do this. You can wait a certain period of time, say 15 minutes, and if the stock breaks above its high of the first 15 minutes after opening to the upside, then look to go long. You can place a stop below the low of the first 15 minutes, or use some sort of trailing stop based upon recent price volatility.

No matter what strategy you apply to daytrading stocks, it is always a good idea to pay attention to those stocks with gap openings! And of course, it is crucial to apply a good risk management strategy, because no trading strategy is full proof. The bottom line is to make more money on your winning trades than you lose on your losing trades. Make that happen, and you will come out ahead in the long run!

Copyright (c) 2009 Scott Cole

Article Source: ABC Article Directory

About The Author: Scott Cole is a market analyst who has developed a number of stock trading strategies. To learn more, visit www.bestdaytradingstocks.com and www.kungfutrader.com