The One Percenters
- Posted by DynamicHedge
- on August 24th, 2012
Did you read the news this morning? Two headlines on Greece had the market’s engine revving. I thought I’d take this opportunity to revisit a market phenomenon associated with a headline rich environment — the gap. Here is my preamble from a previous gap post:
A gap in a chart happens when a stock opens lower or higher than the previous bar. The “gap” traditionally refers to the visible space in the chart that this pattern creates. You usually see them in daily or weekly charts because there is ample time between the close of one session and the opening of the next for news events to change sentiment and the supply demand relationship in the markets. Naturally, in a headline driven market where many market moving events are unfolding, gaps are plentiful.
There are many different types of gaps: breakaway gaps, measuring gaps, exhaustion gaps, and common gaps. I’m going to assume that all gaps are created equal…I don’t care if a gap creates a visible gap pattern in the chart because on the opening of the market PnL losses are real and affect traders regardless of what the chart looks like.
Why are gaps important? Gaps represent the most pure form of market punishment to wrong-way traders and the most pure reward for right-way traders. This is not your run of the mill position slowly trending against you or in your favor — this is a violent rejection or reward of your trading thesis. The acute nature of the pain and pleasure and the trader reactions associated with the emotions of loss and reward leave an unadulterated behavioral footprint on the market.
Below, I’ve pulled every one percent or greater daily gap and run the day’s price action from the last year through my pattern recognition algorithm. Basically, these are the dominant patterns which occur after a gap of one percent or more. The charts labeled ‘Curve 1’ are are by far the most frequently occurring patterns and the charts labeled ‘Curve 3’ are the least frequently occuring. The three curves for each situation explain more about market participant behavior than any market psychology book or so-called guru. Every curve tells a story.
As a side note, we’ve just upgraded from the ghetto streets of standard Matlab charting to the visual oasis of Java charts with luxurious hover-over effects. I’m also getting ready to make this tool available to the general public. The group of traders that stepped up first and helped get this project off the ground will have first dibs, but after that I’ll be opening it up in stages. Shoot me an email if you want in: info at dynamichedge.com.
Gap up (1 percent or greater):
Gap Down (one percent or greater):
Moral of the story? On a big-assed gap, don’t get too crazy off the opening print. You’ve got time. What about all the other various-sized gaps? And what about all the other variables that can possibly affect the gap… stay tuned.
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DynamicHedge is an equities, futures and derivatives trader based on the West Coast. He runs a long/short opportunistic relative-value strategy within a proprietary trading group. More
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