The Power Of Gaps(pdf)

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Have you ever noticed a stock or an index, which seemed to be moving effortlessly in its desired direction, suddenly stop dead in its tracks? Have you ever noticed how this often happens nowhere near a major moving average or trend line? Do you sometimes find yourself watching a trade reverse in your face and not have an explanation as to why this happens?

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The Power Of Gaps By Goran Yordanoff Have you ever noticed a stock or an index, which seemed to be moving effortlessly in its desired direction, suddenly stop dead in its tracks? Have you ever noticed how this often happens nowhere near a major moving average or trend line? Do you sometimes find yourself watching a trade reverse in your face and not have an explanation as to why this happens? More often than not, the answer can be found by identifying areas of gaps on weekly, daily and intraday charts. In order to determine all potential areas of support and resistance when you are evaluating a trade (we all have our targets and stops in mind before we enter the trade, right? Right?) you must always consider gap areas. For clarification, the Japanese refer to a gap as a "window." Most of my charting analysis is based on Japanese candlestick charting theory which was primarily brought to prominence in the United States by Steve Nison. Nison is considered to be the "Godfather" of Japanese candlestick analysis in the United States. While Japanese candlestick analysis has really only been practiced for the past 25 years in the United States (thanks to Steve Nison's research and work), the Far East has been utilizing these principles and theories for centuries. There is a Japanese saying, "A clever hawk hides its claws." For those of us who utilize candlesticks, we believe "the claws" of the market to be hidden within their message (from Nison, Beyond Candlesticks). Let us consider the case of Merck and Co. (MRK). In my Dec. 27, 2000, commentary, I pointed out the potential of Merck and Co. to fall out of its consolidation range due to negative divergences with its technicals. I pointed out potential target areas based on two windows which were formed on gaps up in October, 2000. Let's go back and examine the chart from Dec. 27:
Now let's take a look at MRK's present day chart and summarize what actually transpired subsequent to my Dec. 27 commentary.
As we can clearly see, MRK fell violently out of its trading range in early January, 2001. We can see a multiple-day effort to stabilize at the area of gap #1 (as shown on chart). However, this gap #1 zone was violated and the zone of gap #2 was quickly tested. To date, the zone of gap #2 has halted a further decline in the share price of MRK. However, it is not certain as to whether or not MRK can resume its prior uptrend at this time. This is due to the prior support zone of gap #1 now serving as resistance during rally attempts. Until this new resistance zone of gap #1 can be overcome, MRK appears to be locked in a trading range between its new resistance area of gap #1 and its support zone of gap #2. A break through either one of these zones would suggest continuation in that direction. Most who were observing the recent trading activity of Merck and Co. may have been perplexed by its trading pattern as it seemed to act in total disregard for major moving averages and trendlines. The key to having made a profitable trade in this particular instance was identifying where the market was "hiding its claws." The "claws," as we have proven here, were hidden within the gap areas described above. Copyright © 2001 by TradingMarkets.com, Inc.