Hey Traders,
Today, I want to talk about something I’ve mentioned before in a broad market context, but it’s worth repeating: gaps.
That’s when a stock suddenly jumps up — sometimes on earnings, or maybe a change in management…
Or sometimes just because of some wild, emotional reaction to news that doesn’t really make much sense.
Here’s the deal: A gap happens when the stock price makes a sudden leap, leaving behind a “gap” where the stock hasn’t traded very much.
For example, if XYZ stock closes one trading day at 125 and suddenly moves big overnight, opening up at 150. It leaves a big gap between 125 and 150 where the stock has not traded much, if at all.
You’ve seen this happen, I’m sure.
Now, don’t get me wrong.
Gaps aren’t always the end of the world, but I usually try to avoid stocks that do this for one simple reason: In my experience, gaps tend to get filled in.
What I mean by this is, when a stock jumps up like that, it’s often based on traders’ emotions.
They’re reacting to something — good news, bad news, whatever — but it’s an overreaction.
When that happens, you can bet your bottom dollar that it’s not a sustainable jump.
I know what you’re thinking: “But Jack, maybe this is just a good stock with great news!” And you’re right.
It could be a solid stock, one that’s been trending steadily higher, and in that case, it could still be a good play.
But here’s the thing: That big jump is usually going to fade.
And if you let your emotions get the better of you, you could end up getting into a trade with a stock that’s very likely to correct itself.
Let’s look at MSI for a good example. This is a perfect case of what I’m talking about.
MSI has been on a strong, strong trend for over a year. See for yourself:
In the last 13 months it’s rarely gone below it’s green short-term 20 day trendline.
Then recently, out of nowhere, it shot up, creating a gap in the process. I’ve highlighted that gap on the following chart:
And wouldn’t you know it? The stock which hardly ever went down for over a year, suddenly moved down and has been moving sideways for the past month.
Take a look at the chart again. It hasn’t turned into a bad stock.
Now don’t get me wrong…
It’s still a solid stock, bouncing off its 20-day short-term trendline, just like it was before the gap.
But that that formed in early November? It was one of those “too much, too fast” kind of moves — and so the stock had to move a bit down and sideways as we’ve been seeing it do.
That’s exactly the kind of thing that sets off red flags in my head.
If I were to trade this stock the way I usually do — using income strategies — I’d have to adjust my strategy.
Why? Because I would need to account for the fact that that gap is going to fill in.
So, if I normally sell a spread a few percent down from the current trading price, I would have to adjust my strike prices downward to account for the fact that I’m expecting MSI to come back down and touch its trendline.
And sure enough, just look at the chart — that’s exactly what happened after that big jump.
Gaps are tricky. They mess with your emotions, and they can mess with your trades.
Sometimes traders get FOMO feeling: “Fear of Missing Out”
They think “well, look how high it jumped in just 1 day — it’s on fire! I better get in before it skyrockets!
And usually — most of the time, I’d say — that stock does what MSI did.
It’s normal. After a huge move like that, a stock has to cool off a bit.
So always keep an eye out for those gaps.
When a stock that has been bouncing off its trendline gaps up like MSI did, it’s not a signal to jump in and ride the wave.
It’s a signal to watch, adjust your strategy, and prepare for that gap to fill.
And that’s how you play the odds, folks.
Trade smart. Stay disciplined. And keep your emotions in check.
Trade well,
Jack Carter
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