Reading Gaps in Charts to Find Good Trades (Part 4)

07/22/2010 12:01 am EST

Focus: STRATEGIES

Timothy Morge

President, MarketGeometry.com

(Continued from Part 3)

Now that I know there are whales feeding at the unfilled gap area and price has shown its hand by gapping and closing higher, what I am going to do with this information?

chart
Click to Enlarge

I add a simple trend line drawn from the low of the prior swing low below the multi-pivot line and connect it to the low of the bar that failed to fill the unfilled gap (where the whales have left large limit buy orders). Are there other things to consider?

chart
Click to Enlarge

I pull back for perspective and simply connect the major highs and lows with simple lines. I add a blue, up-sloping line connecting the major low and the low of the unfilled gap, where I know the whales have left limit buy entry orders.

Price has broken above two major swing highs from the long move lower, a sign that a change in behavior may have occurred, although I have mentioned this several times at various places that this is the first time price action has confirmed this potential change in behavior.

Now that both price and market structure have given me what I was looking for, let me show you my orders:

chart
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I want to buy a retest of the green, up-sloping simple trend line at 4.83. My initial stop loss order will be at 4.53, and if my limit buy order is filled, my profit target will be just below the last swing high, at 6.48.

Note that I placed my stop loss order below the low of the bar that failed to fill the unfilled gap, where I know whales have left large limit entry buy orders. If price begins to run through their orders, or if they pull their orders and the gap gets filled, I no longer have the market structure in place that spawned this trade idea.

chart
Click to Enlarge

Sometimes, you must be patient and diligent and stick with your plan until price decides to let your limit orders get filled. As each bar closed (especially because these are daily bars), I move my cursor to see where price will intersect with the green, up-sloping line. In this case, I got filled on the fifth bar. Because I am trading against an up-sloping line and the intersection price climbs higher with the close of each bar, there is a price where the risk/reward has eroded too much or the initial stop loss has gotten too large for me to continue to work the orders associated with this trading idea.

More tomorrow in Part 5…

By Tim Morge of MarketGeometry.com

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