The Buyable Gap
Many beginning stock traders have difficulty grasping the concept of ‘buy high and sell higher’. This is perhaps understandable since many people have at some point heard the super misleading ‘buy low sell high’ which any experienced momentum trader knows is the road to ruin.
This fear of buy high sell higher is particularly noticeable after a stock ‘gaps’ up. Most novice traders look at the chart and see the gap up and think ‘oh this stock is no longer cheap, I can’t buy it up here!’. The large gap up in the chart shakes their confidence. However they are risking on missing out on a golden opportunity because in a strong market the gap up could be signaling a new bullish move and massive building of upcoming upward momentum.
So how do we determine if a stock that has gapped up is ‘buyable’ ? or if it should be avoided? Well, one of the key causes of a large gap up is a game changing event. Momentum traders are interested in growth stocks and leading stocks in their sector with strong fundamentals that ALSO have some game changing event which can cause a gap up and continued momentum thereafter.
Gaps are caused by abnormal trading volume outside of regular trading hours. Certain significant events can cause the gap, such as a CEO change, an activist investor stake, biotech drug approval or rejection, new product launch, and retail sales trends. Looking at what the cause of the gap is can help you determine if a gap is buyable or not. Usually it would be a good idea to buy into a gap up based on blow out earnings – why? Because blowout earnings signify continued growth! The chances of the stock continuing up is more likely because of the great earnings report! Of course it is prudent to keep a tight stop loss as usual in order to protect your downside!
So, even though the majority of stock traders shy away from stocks that have gapped up, momentum traders can take advantage of the move and by looking more closely at what caused the gap and follow the logical thought process rather than being immediately put off by the large and sudden increase in the stock price!
See where i learned my momentum trading strategy HERE