The "Gap" Opening,
Another Short-Term Entry for Fundamentally Sound Stocks
W. Miller, Ph.D.
I've introduced other technical buy
set ups that have proved profitable in either providing low risk entries for
longer term trades or trading shorter term: buying stocks making
21-day lows and
buying stocks in pullback reversing with a "hammer"
candlestick. Today, I want to consider another here, the "gap" opening.
What makes these reports unique is their focus on the
response from fundamentally sound stocks. They provide one a lower
risk entry into stocks that are fueled to continue long-term bullish
runs based on earnings fundamentals. A strict technician, like Gary
Smith on "Bulls and Bears," would use these type buy setups on any
stock, regardless of its company fundamentals, and they would work
as short-term trades, perhaps with not the same probability of
success. The insistence on fundamentals gives me greater confidence
that TSM trades will be successful over the longer term because
these stocks will be more readily supported by institutional
Let's talk about opening gaps. First, there are two
kinds: one where today's open falls below yesterday's low (candles A
and B in the chart below) and two where today's open falls higher
than yesterday's high (candles C and D). The first will be bearish
if the gap remains open and price continues to fall, and similarly,
the second will be bullish if it resists closing. Both will reverse
their bullish/bearish tendencies should the gap actually close. In
this work, I looked for down gaps that reversed and for up gaps from
this week's TSM stocks investigated over the 1/1/04 to
2/24/05 time frame: 17 stocks, 288 trading days each (total of 4,896
trading days). To qualify, each gap had to be 1 percent of price in width,
and the reversal gap had to penetrate yesterday's low by at least $0.06
before buying. In total, there were 40 gaps of the first type--fewer than I
expected--and105 gaps of the second. Below, the down red arrow highlights a
down gap reversal, and the up red arrow highlights an up gap. In these two
cases, both trades were very profitable.
For buys at a down 1 percent gap reversal followed by a
$0.06 penetration of the previous day's low, the percentage profit gained by
selling the same-day close to the closes 1-day to 10-days later (blue data
below) were calculated. For the up gap, I modeled the buy at the gap open,
then looked at the percentage profit gained by selling the same-day close to
the close 1-day to 10-days later (red data below). As a control, for each
stock, I modeled the buy at today's open, then the same-day sale at the
close or the close 1-day to 10-days later (green data below).
Obviously, the gap strategies performed better than did the
control, generating a 3.25 (2.64 x control), a 1.90 (1.54 x control), and a
1.23 percent return after four days, respectively for the gap up, gap down,
and control strategies. Too, 10-days into the trade there were no
differences. Even the control was bullish over a 10-day period, but
remember these are a group that have performed well over the last year.
Note, these strategies could be improved by utilizing a stop-loss strategy.
That wasn't done in this modeling.