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Let's accept the definition of gap as follows: you have a gap when a financial asset opens at a higher or lower price than it closed the prior day: the empty space from yesterday's close to today's open. If you accept that all information known about a stock or commodity is reflected in the price at any given moment, prices will not significantly change until some new perception of the future value of the stock or commodity enters the marketplace. Gaps are the result of some event happening while the market is closed. But gaps can occur also because of noise, which, depending on the asset, can have different contributions to the single bar range. Whatever the reason, the result is buying or selling pressure at the open of the next day, which will make the asset open at a different price than where it closed.
Let's have a look at the table below. It reports the DOW Jones Industrial Average 30 shares statistics based on the last 1000 trading sessions
Probability of Gap Up/Down Conditional on past 1 or 2 days being Down
|Ticker||Gap Up||Gap Down||Gap Up|
After 1 Down
After 1 Up
After 2 Down
After 2 Up
In the table, you can see the probabilities of each event. Note that the general tendency in the past 1000 days in 22 out of 30 stocks has been to have up gaps. Could this be due to the fact that since the end of 2002 most stocks are in an uptrend? If this is the case, it means that there is a structural tendency to have up gaps in an uptrend, which is not exactly a random behaviour. Note also that some stocks, like General Motors are in downtrend. Nonetheless, GM presents an up gap prevalence.
If we go on with our analysis, you will see that after a down close the percentage of up gaps for the 30 stocks increases 29 times out of 30. Percentages even improve after two consecutive down closes 24 times out of 30 (with respect to the up gap after 1 down close). The same behaviour can be found when observing the down gaps. It seems that after negative sessions, investors are brought to buy at the next day's open.
Paolo Pezzutti is a Commander in the Italian Navy with a passion for technical analysis and short-term trading.