Looking at Gaps on SPY

One of the things I watch intently in analyzing a chart are gaps. A gap occurs when the opening price is much different from the previous closing price. This is often due to a news item....like the news about Freddie Mac and Fannie Mae this past weekend.



Most significant gaps are eventually filled, meaning that price will eventually come back to the origin point of the gap. I have seen statistics on this from sentimentrader.com, and as I recall most gaps are filled within 30 days. I always look for these gaps to be filled in order to set up a low risk entry point for a trade. That is because as soon as a gap is filled, the trend often continues.



So, as pertains to our current market and the chart of SPY.......we had a gap down last Thursday. That gap has now been filled by today's huge gap up this morning. In addition there has been an obvious bearish reaction to the gap up today. I pretty much expected this, and feel that price is unlikely to be able to make much headway in coming weeks. the question now is "how will the market respond if/when today's big gap gets filled?"



I expect maybe a short pause, but I would not look for a large upside reaction to that gap.



The take home message is that you should pay attention to those gaps if you trade DIA, SPY, QQQQ, etc. Look for reversal points shortly after the gap gets filled. Pay attention to how the market responds when the gap is filled. Does it blow right through? or do you get an almost immediate reversal?



As an aside, I bought DIA Oct. 114 puts this morning around 11:00 am ET, so I do have a bias here. I will not track that on the blog, but that trade reflects my views about the gaps mentioned above.



Pete