Reading Gaps in Charts to Find Good Trades (Part 5)

07/23/2010 12:01 am EST

Focus: STRATEGIES

Timothy Morge

President, MarketGeometry.com

(Continued from Part 4)

After moving my order higher four times, I am risking 63 cents to make a potential $1.32, which gives me a risk/reward of just over two to one. I rarely take trades with risk/rewards under two to one, so if I had not gotten filled on this bar, I probably would have pulled the order. I also like my retests to be between three and five bars after the initial test; once it takes more than five or six bars, I will generally pull my orders and watch price again, waiting for another clear sign that there are buyers or sellers in the market.

But I do get filled on the fifth bar at $5.16. I immediately check to make sure my initial stop loss is in the market and then I enter my limit sell order (my profit order) at $6.48. Then I check again to make sure I bought the amount of shares I wanted to buy, and at the price I wanted to buy them. Now is the time to find any problems, not after price has moved far away from this level. Once I am sure I have the position I want, and at the price I expected, I double check the orders I am working in the market. Now I have to watch price and execute the plan I made before entering the position.

chart
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Once I am long at $5.16, the next several bars are uneventful; then price begins to creep higher. When price gaps open higher and closes quite a bit higher, I cancel my initial stop and enter a break even stop loss order. Remember, the original risk/reward on this trade was barely acceptable to me, so this unfilled gap gives me an opportunity to “collapse” my risk. If price is not heading higher from here after leaving another higher unfilled gap, I don't want to lose money on this trade.

chart
Click to Enlarge

Once I moved my initial stop loss order to a break even stop loss order, price made an orderly climb higher and my limit sell order was filled at $6.48 four bars later, giving me a net profit (before brokerage) of $1.32. You can see the unfilled gaps played a major part in my thought process and decision making. Many traders don't understand the significance of gaps, and this article has just scratched the surface of their meaning and how to use them to your advantage. But understanding and using unfilled gaps, as I have in this example, is something you can practice and ultimately add to your trading tool kit.

I hope you found this example interesting and informative.

I wish you all good trading!

By Tim Morge of MarketGeometry.com

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