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Michael C. Thomsett is a widely published options author. His "Getting Started in Options" (Wiley, 9th edition) has sold over 300,000 copies. He also is author of "Options Trading for the Conservative Investor" and "The Options Trading Body of Knowledge" (both FT... More
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  • Chart Analysis – Be Aware Of Hidden Gaps, Invisible But Important Signals 0 comments
    Jan 20, 2013 10:09 AM
    Technical analysts appreciate the importance of price gaps and, in fact, may base entry and exit decisions on strong momentum that is characterized by rapid gapping price movement.

    However, not all gaps are visible. The elusive hidden gap occurs more often than you might realize. While many of these invisible gaps are defined as "common" gaps and lack any specific reversal or continuation significance, others act as part of important changes in the current trend. When this is the case, invisible gaps should be tracked and analyzed in context to make sure you do not miss an important early warning sign of coming reversal.

    Candlestick charting is popular because each session's real body and its shadows tell you all you need to know - open and close, trading range, and direction of price movement. It is also quite easy to spot gaps between sessions. The distance between one rectangle and another is clearly visible on every chart. Even so, invisible gaps may easily outnumber the easier to find visible gaps, in six configurations. These are shown below.

    There are six ways that invisible gaps form. In each instance, consecutive session "real bodies" (candlestick rectangles) overlap. At first glance, this means the sessions do not contain gaps. But as the lines drawn between sessions reveal, the distance between one session's close and the next session's open contain gaps. A white candle is an upward-moving day and a black candle is downward-moving, so the gapping action in these cases is not visible.

    When is this important? There are three instances when invisible gaps have to be spotted and acted on:

    1. The price moves through resistance or support in a breakaway pattern. When the gap occurs at the beginning of a strong new trend, the invisible gap is possibly the most important session of the change. This is especially true when price moves above resistance or below support and does not then reverse to fill the gap.

    2. The invisible gap is a part of recurring gapping sessions. A lot of momentum is not spotted right away because traders are aware only of visible gaps. Those interim "non-gapping" sessions could consist of invisible gaps, making the new momentum much stronger than it appeared at first glance.

    3. The momentum shift is confirmed by other signals. Candlesticks work best when the indicated meaning of a pattern is confirmed by independent indicators. So when invisible gaps occur along with volume spikes, changes in momentum oscillators, or within recognized technical patterns (like double top and bottom movement or head and shoulders, for example), those gapping sessions strengthen the initial indicators.

    Gaps may be visible or invisible, but all gapping action points to greater volatility. When that action is part of a trend reversal or test of a trading range, it is a strong indicator requiring fast action. Being aware of the invisible gap vastly improves your analytical skills and shows you reversal trends before most others see them.

    I rely on strong reversal signals on stock charts as my primary method for timing option trades. I don't rely as much on implied volatility, especially in the option's final month when volatility collapse makes this approach useless. I track a virtual portfolio on my website, ThomsettOptions.com where I have had considerable success using this system, along with strong confirmation. I hope you will visit the site and check out the portfolio's performance. Link to http://tinyurl.com/aqeeops o get started.

    I have also begun publishing a free weekly options newsletter, which includes details of trades, valuable links, and other items of value to anyone interested in trading options or in learning how it all works. All you need to get started is your e-mail address, and you will receive this free newsletter every week. Link to it at http://tinyurl.com/axmf66o

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