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Gaps may serve one of three purposes. They are used to spot the
beginning of a move, to measure a move and to signal the end. There
are four different kinds of gaps: common or temporary, breakaway,
measuring or runaway, and exhaustion. The most frequently
occurring gap is the common gap. When this gap occurs because of a
slight change in psychology, traders expect it to be filled soon. Once
a gap is filled, it no longer has significance.
The early portion of the soybean chart on this page shows common gaps
during the December and January period which were later filled.
The breakaway gap on this chart occurred on May 7 and begins a major
bull move. Breakaway gaps often occur after a stretch of sideways
trading and in the leading days of an uptrend or downtrend. This type
of gap remains unfilled for a long time.
It sometimes is difficult to tell right away that it's a
breakaway gap and not a common gap. When the market fails to fill this
gap after a couple of weeks, this confirms the breakaway gap.
One of the most easily recognizable technical signals in trend change is
the key reversal. A key reversal often has an unusually wide trading
range. Its requirements are a day's range outside the previous day's
range with a close higher than the previous close for an upward
turnaround and a lower close for a downward turn. |
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Gaps are filled is another
time-tested rule of the market. That is why gaps become future price objectives.
Quite often, prices retreat to fill a gap in a bull market before continuing the
move. Likewise, prices often rally in a bear market to fill gaps.
"Thin markets" — those with very low open interest and trading
volume — will create false technical signals. These markets, as well as
deferred contracts which also have low open interest, should be avoided by
inexperienced traders.
Despite these cautions, technical analysis is a powerful tool
and if used with common sense, can enhance a trader's perspective and
profits.
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