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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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  • Candlesticks – The Gap Filled Pattern 0 comments
    Mar 30, 2014 10:30 AM

    Some price gaps are "filled" - meaning price moves back to close up the difference in price levels. Other gaps are not filled. These tend to be found in very strong price moves, often as part of a breakout above resistance or below support.

    A gap filled pattern is important because it does not indicate a new trend is underway. Knowing what is not happening is just as important as knowing what is, when it comes to trends.

    Common gaps occur often in trading. In fact, if you study day-to-day differences between closing price and the next opening, you might be surprised to find out that gaps take place regularly. It can be deceptive, however, because some gaps are not visible. So when you see two sessions with different-colored candlesticks, an invisible gap is probably part of that pattern.

    A gap filled is made up of one of two types, upside and downside. An upside gap filled is found in at least two sessions and consists of four attributes: a white candlestick, an upside gap, a second upward session, and then a downward session that does two things: It fills the gap, but it does not fall below support set by the first day's open.

    This distinction is key to reading the pattern; if the last day does fall below that interim support level, then the retreat is clearly bearish. Once that support level is violated, a subsequent uptrend is much less likely to occur.

    A downside gap filled is the opposite in terms of direction, but the same "rules" apply. It is made up of a black session, a downside gap, a second downward session, and then an upside session. Like its upside companion, the downside gap filled's last day fills the gap but does not move above resistance set in the first session. If the price does continue upward, then the suggested downtrend is not likely to occur.

    These gap patterns are especially important in candlestick analysis because they can help you to find false signals. Short-term support and resistance are different than the more established trading range. These apply only for the relatively brief duration of a developing short-term trend. However, gapping patterns are among the few candlesticks that make use of support and resistance as a means for testing the validity of the trend. It might be developing as it appears, or it might be a misleading signal that ends up moving in the opposite direction.

    Short-term support and resistance activity can also be useful when the gapping action leads to a new trading range. On the upside, you may consider the previous resistance (not broken through) as a tentative new support level. This flipping of levels is common. On the downside, a now-violated support level is likely to become a new short-term resistance level.

    These interim trading range observations will help to determine whether candlestick indicators - -especially those involving gapping action - are reliable in setting a new trend, or just a failed attempt at moving beyond the current trading range.

    To gain more perspective on insights to investing observations and specific analysis, I hope you will join me at ThomsettStocks.com where I publish many additional articles. I also maintain a virtual portfolio of stock at ThomsettStocks.com. For new trades, I usually include a stock chart marked up with reversal and confirmation, and provide detailed explanations of my rationale. Link to the site to learn more.

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