Wednesday, December 2, 2009

Thoughts On Recent Gap Activity

A trader I know pointed out the unusually large gap activity lately. I track the 10-day absolute average gap over the 100-day absolute average gap on the charts page in the members section of the site. Meanwhile I observed the average true range is still below normal. I’ve copied the two charts from the website to illustrate.

The real odd behavior here is with the average gap size. Such gappy behavior is unusual with the market near new highs. It’s also unusual when there isn’t also a substantial increase in the intraday range. I looked at this a number of different ways last night. The 10/100 Absolute Avg Gap is 1.38 (meaning the 10ma is 38% larger than the 100ma of the overnight gap size). I looked at other instances where similar levels were approached and the market was near a new high. It’s been fairly unusual over the last 15 years and results were inconclusive.

I then look at comparing the size of the average gap to the size of the average intraday range (not the true range as shown above). Here again I found we are at very high levels but past history was choppy and inconclusive.

Lastly I looked at times where the 10-day average gap was well above normal and the 10-day average intraday range was well below normal. Again I could find nothing suggesting a significant directional edge.

So is this activity suggestive of anything? Perhaps. While the readings themselves don’t seem to help greatly in predicting direction, they do indicate some unusual behavior. My take is that the market is being influenced more by outside forces than is customary. It’s been noted by many that the dollar has been leading everything by the nose lately. Outside influences like Dubai debt have also had an overnight influence lately. This would seem to explain why such a large percentage of action is occurring overnight.

So what should we do about it as traders? Two things come to mind – 1) Be more cognizant of dollar and other intramarket action. 2) Perhaps don’t put quite as much weight on standard price, volume and breadth indicators as usual. The studies have done quite well as of late. Still, it may be worth trading with a bit more caution than usual until the stock market manages to decouple from the dollar a little bit.


Patrick said...

Rob you really should run some studies on overnight FX patterns, I've noticed some pretty steady tendencies between sessions from trading FX and, occasionally, staying up all night to do so (not recommended as a discipline, but interesting from a scientific standpoint.) Basically the Asian session/London session switch bears a large statistical clustering of pivots that define major swings and NYC-based action is often gapped out of the interesting opportunities. I really think the best opportunities for hedge funds in the future will be in direct wire FX transactions, as these ameliorate many systemic risks inherent to OTC derivatives and exchange traded instruments alike, and also I think it'll become increasingly clear the a sustainable edge can only be found in automated trading of 24-hr markets.

Ron Dodson said...

I think the bigger gaps are evidence of the US market having less leadership than before.

Stock said...

I did my own little study of gaps and came I with interesting results, although I haven't confirmed the data.

ilene said...

Hi, this is from Phil's Stock World, where Phil was looking at this issue in his two week review. Here's what he wrote:

Rather than just wrapping up this week’s moves, I thought we’d add the prior week as the pattern is very much the same (and it was the same the week before) so it certainly bears (oops, don’t say bears!) studying. Of course, when I talk about patterns, I don’t just mean the chart pattern where we have all of our gains for the week on Monday and Tuesday on low volume and then larger volume selling for the rest of the week as the funds who pump the futures up dump their ill-gotten gains on retail investors. I’m talking about the global new patterns, as reported by the MSM, that make this sort of manipulation so effective. It’s not that I’m so good at predicting things - it’s really just that I’m good at spotting the BS…

Monday - Stuffing the Futures for Thanksgiving
I was pointing out that morning that 90% of the market gains since October had been coming on a single day each week and how a lot of that was happening in the very thinly-traded Futures market, where a few thousand shares traded overnight are able to lever the entire US market up by Trillions of Dollars. It’s a very sick and broken system that has been seized by manipulators to yank investors around, making sure retail investors have little ability to participate in these wild market moves as the game is already over by the time trading starts the next day.

This week, we had 2 days like that with both Tuesday and Friday gapping up over 100 points at the open, accounting for 250% of the week’s gains. So a few thousand futures contracts added 250 points to the Dow this week while most traders slept and then 150 points were sold off in active trading as retail investors tried to play catch up (spurred on by hedge-fund lackeys like Mr. BUYBUYBUY) and end up being the ultimate bag-holders. That’s what I see going on for the past few weeks, the funds are exiting the game while herding in as many retail investors as they can get their hooks into before they pull out the rug (after they cash out and flip short) so they can force another bottom where they’ll buy again while telling the retail investors to get out and save themselves.

For access to the full articles by Phil, go to my site and there's a free trial offer on the right side: