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Tales of a Technician: Dealing with Down Gaps

January 28, 2020

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Tales of a Technician: Dealing with Down Gaps

This morning’s whack was the first 1%+ gap traders have had to deal with for months. We’ve been accustomed to such a low volatility grind higher for so long that some have forgotten asset prices go up and down. In this morning’s trading lounge we discussed a half dozen ideas for how to manage positions during the downdraft.

We even recorded the best part for those who missed it. You can view it here.

I wanted to follow-up with some comments on how I would modify my use of the Options Report picks when the market has such a large change between Friday (when the report is compiled) and Monday (the first time you can trade any of the picks).

I suggest having your charting platform handy so you can look at each ticker as I walk through them. It’s a pain to upload them all. Forgive me:)

Modifying Bull Picks

Here’s how I would have adjusted my use of the bull picks after this morning’s gap.

First, remove any stocks whose gap invalidated whatever pattern got them on the list in the first place. For this week’s Options Report the only obvious one that fits this is JBL because the gap took it below the bottom of its high base and broke short-term support. The stock isn’t trade worthy until it builds a new pattern or returns to the $44 resistance zone.

I find it impressive that JBL is the only one that performed poorly enough to justify its removal. Particularly given this morning’s bloodbath. CIEN is borderline too weak for keeping it as a good bull pick for the week, but it didn’t break the low of its consolidation zone. And now that I’m looking at it LULU is similar to JBL too. Today’s drop broke the low of its high base pattern as well.

Second, as long as the bull retracement and/or breakout setups are still intact after today’s beatdown, then the stocks in our report are still playable moving forward. This assumes, of course, that you’re comfortable enough entering bullish trades and increasing portfolio exposure in the face of the pullback. The stocks that fit in this category are COST, CRM, DISH, PLAY, SQ, ULTA, and WDAY.

The third group includes those that triggered or gapped past trigger points and includes GLD, GDX, and AEM. I’m not a fan of chasing if the stock’s gap too much. GDX is the perfect example of one that I wouldn’t have entered because the up gap carried it directly into overhead resistance.

On to the bears.

Modifying Bear Picks

You would think the bear picks would be loving the weak open, but it’s not as a total slam dunk. The primary problem is the gap robs us of the ideal entry point. Take TECK, for instance. We were looking to trigger below Friday’s low of $14.19, but by the time the market opened, it was already trading down 3.2% at $13.74. You still would have profited if you entered, but there’s no doubt the gap stole some of the potential gains.

AIG, FSLR, and DLTR had similar issues, though their gaps weren’t as substantial. Here’s a pro tip. Consider removing your entry orders before the market opens on the day of a large gap. Let the market trade for 5 to 15 minutes. Then mark the low of the period and use that as the new trigger. Most stocks made their lows in the first minute or two, then rallied back for much of the day. DLTR is a good example of this. It would have been annoying if you were triggered in at the open because it ripped higher and closed near the high of the day. This technique would have prevented you from getting filled.

Elsewhere, the bear breakout setup in SBGI is still intact and ROKU just triggered.

Volatility Watchlist

Since the volatility was full of earnings trades, consider it completely unaffected by this morning’s drama. Except for EEM, that is. If anything, it looks even more attractive now. Implied volatility is higher and its price lower. That spells juicier premiums and a wider range of profit. You can now consider lower strike prices for naked puts than what was feasible on Friday.

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