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Gaps, The Novice Trader Exposed
Education | 17 February 2012
By:

By Sam Seiden (Online Trading Academy)

In our live trading rooms at Online Trading Academy, we always make a big deal about gaps as they produce some of the lowest risk, highest reward, and highest probability trading opportunities for our students. One thing is very clear from our experience: Those who know what they are doing get paid from those who do not. In other words, the professional trader makes his or her income from the novice trader. Gaps are the most obvious way to spot a novice market speculator. Be careful, if you cannot spot the novice, consistently losing trader in a market, it is probably you.

Gaps in price are great because they are the picture of the ultimate supply and demand imbalance when you understand them. Not every gap sends the same message so we structure them into an understandable checklist. Once this is done, we can use this information to spot the novice market speculator and be there to take the other side of the trade.

Below is a chart of the Singapore ETF (EWS). Notice the overall trend is up. Next, we identify that demand level as a price level where willing demand exceeds willing supply because price could not stay at that level and had to rally. How much demand is in that level? We ask ourselves a few questions in the trading room related to something we call “Odds Enhancers” to figure this out.

Below is a chart of the Singapore ETF (EWS). Notice the overall trend is up. Next, we identify that demand level as a price level where willing demand exceeds willing supply because price could not stay at that level and had to rally. How much demand is in that level? We ask ourselves a few questions in the trading room related to something we call “Odds Enhancers” to figure this out.

Daily Chart Of Singapore ETF (EWS)

First, “how did price rally away from the level”? Here we had a gap higher from that demand level. The stronger the move in price away from a price level, the more out of balance supply and demand is at the level. Next, “how much time did price spend at the level”? While trading books tell you that when looking for key support and resistance levels on a chart, you should look for areas where lots of trading took place with many candles on the screen, we say the truth is the opposite. At price levels where supply and demand are most out of balance in any market, you are going to get very few transactions (trades). Therefore, this is going to be very few candles on the price chart, not many like the trading books say. So, because price gapped up from that demand level and spent little time there just before the gap, we conclude that there is a big supply and demand imbalance at that level, tons of willing demand.

Now let us focus on the gap down when price revisited that level, noted as “novice sellers” on the chart. That is exactly where a trained trader is going to buy, but why? Think about the actions of that seller on the gap down, specifically, the three key mistakes the sellers were making. First, they were selling in the context of a market whose average price was rising (uptrend). Second, they were selling after a decline in price, the gap down. Third and worst of all, they were selling right at a price level where the chart already told us demand exceeded supply.

Anyone who sells after a period of selling and at price levels where demand exceeds supply is going to lose most of the time, the laws of supply and demand ensure that. When we see someone commit these mistakes, we want to be there to take the other side of that trade. Another word for demand is wholesale and retail for supply. So in reality, we just buy at wholesale prices from people who sell at wholesale prices.

Here are some rules to keep in mind when you spot a gap:
1) A gap up in price, into supply, and in the context of a downtrend is a very high odds shorting opportunity.
2) A gap up in price, in the context of an uptrend, is a lower odds shorting opportunity and actually can be a buying opportunity when there is a significant profit margin.
3) A gap down in price, into demand, and in the context of an uptrend is a very high odds buying opportunity.
4) A gap down in price, in the context of a downtrend, is a lower odds buying opportunity and may in some cases be a shorting opportunity when there is a significant profit margin.

When you are ready to take a trade, simply ask yourself “who is on the other side of my trade” and make sure you are trading with someone who is making a big mistake according to the laws of supply and demand.

Instead of looking at red and green candles on a chart and following a conventional technical analysis book, start looking a little deeper and begin to understand the order flow going on behind the scenes that is responsible for the creation of those candles.

These basic thoughts will likely give you an edge over those who are on the other side of your trades and having that edge is the key to trading anything. If you are tired of transferring your account into someone else’s, stop looking at the market the same way everyone else does.

For more insightful reads, visit www.tradingacademy.com/singapore


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