MIND THE GAP
One of the tools I've built and that I use a lot is a predictive factor model that identifies technical trading patterns. I purposely avoid talking about this model too much because most of it is based on factors I developed through my own research and I consider them to be proprietary.
However, given what I'm currently seeing in the market, one particular technical pattern is forming that could explain how the market performs for the next few months and it now seems a relevant topic of discussion. I call it the 'Fill Gap' pattern.
I'm sure I wasn't the first person to notice this phenomenon but I developed the pattern recognition based solely on my own observations and experience... so I'm taking full credit for it!
The premise is that moving averages act as support and resistance levels for equity prices and when different moving averages diverge as a result of volatility or momentum a gap is created. I measure this gap in terms of variance relative to historical relationships between two averages - typically the 20 and 50 day moving averages. I have previously discussed this factor I call 'Moving Average Variance.'
When equity prices are outside of the moving average variance gap (which I'll now just refer to as the 'gap'), the factor represents likely continued price movement, either positive or negative. The longer a price has direction, the gap measurement will tend to normalize as the relative relationship will adjust to prolonged separation. However, when equities experience short bursts of price action the gap will widen quickly and the measurement will spike. Sound familiar?
Back in April, the Chinese technology stock 58.com (WUBA) experienced a dramatic price shock. The stock had been in breakout pattern and at the start of trading on April 14th it was at $52 and had an ATR of $2.48... in that one day however, it moved more than $17 and finished the day close to $68 and its ATR spiked to $3.42. For the next couple of weeks, the momentum continued and the stock traded close to $84 a share... but then, the music stopped and the stock just sat in the high $70s for the next month or so.
Here's the chart:
I extended the 50 day moving average line to give some context as to how the gap formed. The vertical red line represents the approximate point at which the gap was at its widest. Here, the variance between the two moving averages was 4.75... close to 5 times the normal distance the two measurements are from each other.
FILLING THE GAP
Looking at the 58.com example, once the 20 day moving average caught up to stock the price just sat and didn't move again until the gap closed and the price broke out to the downside. So in this case, the gap was never really 'filled.'
Let's look at another example. Here's a chart of the oil ETF USO.
In this example, we have two visible gaps both highlighted by red circles.
In the first instance (the long oval in the middle of the chart), once the price of oil moved below the 20 day moving average it began to bounce off of the support and resistance levels until the gap closed and then broke out to the downside. This movement inside of a gap is what I call 'filling the gap.'
In the second instance, we see the price of oil once again moved inside a large gap and it is now trading inside of this new range.
WHY DOES THIS MATTER?
These gap filling patterns represent a sort of consolidation or a time for price action to recuperate from prolonged or sudden movements... very much like resting after a long run or a short sprint.
Once prices move out of these ranges, however, they are very often ready to move again... or breakout and this represents a great money making opportunity for traders.
To bring this full circle, I now see the S&P forming a large gap that can give us a couple of clues as to what the overall market will do in the coming months.
Here's a look at the current SPY chart:
I like to call this the 'Spy Gap' because I think sounds like something you'd hear in a James Bond movie. Anyway, the current gap is measured at about -3.25... that's very big for an index the size of the S&P.
From a technical standpoint the 20 day moving average could very well act as resistance and push the index down further. However, if prices move inside of this gap it could lead to a period consolidation before we get the next big price move.
There are always fundamental factors at play in markets and that shouldn't be discounted but it seems like charts tend to give us the best indications of how markets will react to those fundamentals.
One of the tools I've built and that I use a lot is a predictive factor model that identifies technical trading patterns. I purposely avoid talking about this model too much because most of it is based on factors I developed through my own research and I consider them to be proprietary.
However, given what I'm currently seeing in the market, one particular technical pattern is forming that could explain how the market performs for the next few months and it now seems a relevant topic of discussion. I call it the 'Fill Gap' pattern.
I'm sure I wasn't the first person to notice this phenomenon but I developed the pattern recognition based solely on my own observations and experience... so I'm taking full credit for it!
The premise is that moving averages act as support and resistance levels for equity prices and when different moving averages diverge as a result of volatility or momentum a gap is created. I measure this gap in terms of variance relative to historical relationships between two averages - typically the 20 and 50 day moving averages. I have previously discussed this factor I call 'Moving Average Variance.'
When equity prices are outside of the moving average variance gap (which I'll now just refer to as the 'gap'), the factor represents likely continued price movement, either positive or negative. The longer a price has direction, the gap measurement will tend to normalize as the relative relationship will adjust to prolonged separation. However, when equities experience short bursts of price action the gap will widen quickly and the measurement will spike. Sound familiar?
Back in April, the Chinese technology stock 58.com (WUBA) experienced a dramatic price shock. The stock had been in breakout pattern and at the start of trading on April 14th it was at $52 and had an ATR of $2.48... in that one day however, it moved more than $17 and finished the day close to $68 and its ATR spiked to $3.42. For the next couple of weeks, the momentum continued and the stock traded close to $84 a share... but then, the music stopped and the stock just sat in the high $70s for the next month or so.
Here's the chart:
I extended the 50 day moving average line to give some context as to how the gap formed. The vertical red line represents the approximate point at which the gap was at its widest. Here, the variance between the two moving averages was 4.75... close to 5 times the normal distance the two measurements are from each other.
FILLING THE GAP
Looking at the 58.com example, once the 20 day moving average caught up to stock the price just sat and didn't move again until the gap closed and the price broke out to the downside. So in this case, the gap was never really 'filled.'
Let's look at another example. Here's a chart of the oil ETF USO.
In this example, we have two visible gaps both highlighted by red circles.
In the first instance (the long oval in the middle of the chart), once the price of oil moved below the 20 day moving average it began to bounce off of the support and resistance levels until the gap closed and then broke out to the downside. This movement inside of a gap is what I call 'filling the gap.'
In the second instance, we see the price of oil once again moved inside a large gap and it is now trading inside of this new range.
WHY DOES THIS MATTER?
These gap filling patterns represent a sort of consolidation or a time for price action to recuperate from prolonged or sudden movements... very much like resting after a long run or a short sprint.
Once prices move out of these ranges, however, they are very often ready to move again... or breakout and this represents a great money making opportunity for traders.
To bring this full circle, I now see the S&P forming a large gap that can give us a couple of clues as to what the overall market will do in the coming months.
Here's a look at the current SPY chart:
I like to call this the 'Spy Gap' because I think sounds like something you'd hear in a James Bond movie. Anyway, the current gap is measured at about -3.25... that's very big for an index the size of the S&P.
From a technical standpoint the 20 day moving average could very well act as resistance and push the index down further. However, if prices move inside of this gap it could lead to a period consolidation before we get the next big price move.
There are always fundamental factors at play in markets and that shouldn't be discounted but it seems like charts tend to give us the best indications of how markets will react to those fundamentals.
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