Can you please address what it means for a stock to “fill a gap” and what the probability for this is?
A gap occurs when a stock opens higher or lower than the previous closing price. It is caused by either high demand for the stock or heavy selling pressure. How high or low it gaps depends on how high or low the market maker has to move the stock to find a seller (upside gap) or a buyer (downside gap). Tomorrow we will most likely see BRCM and SEBL gap higher based on their earnings numbers.
The question is whether the gap will be filled. Some say all gaps will be filled, but that is not necessarily the case. Indeed, we have seen trend reversal (aka, key reversal) gaps occur and the stock never comes back to ‘fill the gap.’ We have also seen cup with handle breakouts where the stock exploded out of the pattern and never came back. As for probabilities of filling, it depends upon the stock, the news (if any), the strength of the market, and the pattern. What happens is that the initial demand wears off and the stock slides back down to the point where it gapped up (the close immediately before the gap). The stock will either bounce up off of that point or slide lower.
We often see stocks breakout on a gap and then test the breakout. They can partially or completely fill the gap. We see others that gap higher, race up even more, and then come back to test where they gapped up to before taking off again. One fills the gap, the other does not. The main thing we look for is whether the test comes on lower volume, preferring that the stock hold most of the gap, and requiring that it hold the pivot point on the breakout. After that we don’t really care as we can take positions on the move up from there as well.
Sometimes we play a gap short term that jumps higher and does not fill the gap that day or the next. If it continues up, we climb aboard, but are ready to get off when it shows signs of peaking on the run. Then we can get back on if the test is successful. There are many ways to play a gap as you can see. When we have options we tend to take the profit on what appears to be the peak of the gap and wait for the test before taking additional positions. On longer term positions we can ride down the test if we so desire as long as the stock does not violate our rules on gaps as outlined above.
