Pekelo's 2nd gap rule
- Thread starter Pekelo
- Start date
right now theres a gap in 30 yr bonds, Im on T.O.S. charts and they are marked in 100s of a point,they gapped above a downtrend res line from 116.82 to 18.22 on 2/28, on 2/29 the rallied to 19.94, that to me is a gap that will be backfilled to that res line which is now support at 15.75, is that the type of gap your talking about
Time to revive this thread, because I want to address 2 issues.
Someone asked earlier ( a year ago) what constitutes a gap?
We had a good example 2 days ago. On Friday all indeces gapped down and after going lower first, in the afternoon they made an attempt to close their gaps. The DJX and the NDX successfully did it, but the SPX had a 1.5 point gap unclosed.
Now in my accounting this count as a successful gapclose because:
1. The other 2 indeces did it.
2. The effort was great, and 95% of the gap closed.
3. I don't really see a 1-2 points gap as one that effects the market's behaviour.
So for all practical purposes, I didn't count that little leftover as a gap, and apparently neither did the market, because we had another gap down by Monday morning and it didn't get filled during the day. Had I counted Friday's downgap still open, I would have expected the Monday's gap to be closed during the day based on the 2nd gap rule.
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Now the other topic is how to use the 2nd gap rule for overnight trading. Once we have a gap left unfilled during the day, there is a high probability trade going towards the gapfill overnight. I call this high probability the "2nd gap rule protection".
Here is how it works: On Monday we had a downgap left open. According to the 2nd gap rule, if we have another downgap by Tuesday morning that would have a very high probability getting filled during the day, so our downside risk is limited if we go long overnight, assuming one has the ability to withstand a possible downdraw.
Sure enough, if you went long just after the cashclose on Monday, you were rewarded with a 14pts move in your direction before it fell back again.
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Note: For determining a gap, I use the cash price and not the futures, because they could be very different and I don't think futures gaps have the same drawing power as the cash gaps do...
Someone asked earlier ( a year ago) what constitutes a gap?
We had a good example 2 days ago. On Friday all indeces gapped down and after going lower first, in the afternoon they made an attempt to close their gaps. The DJX and the NDX successfully did it, but the SPX had a 1.5 point gap unclosed.
Now in my accounting this count as a successful gapclose because:
1. The other 2 indeces did it.
2. The effort was great, and 95% of the gap closed.
3. I don't really see a 1-2 points gap as one that effects the market's behaviour.
So for all practical purposes, I didn't count that little leftover as a gap, and apparently neither did the market, because we had another gap down by Monday morning and it didn't get filled during the day. Had I counted Friday's downgap still open, I would have expected the Monday's gap to be closed during the day based on the 2nd gap rule.
----------------------
Now the other topic is how to use the 2nd gap rule for overnight trading. Once we have a gap left unfilled during the day, there is a high probability trade going towards the gapfill overnight. I call this high probability the "2nd gap rule protection".
Here is how it works: On Monday we had a downgap left open. According to the 2nd gap rule, if we have another downgap by Tuesday morning that would have a very high probability getting filled during the day, so our downside risk is limited if we go long overnight, assuming one has the ability to withstand a possible downdraw.
Sure enough, if you went long just after the cashclose on Monday, you were rewarded with a 14pts move in your direction before it fell back again.
----------------------------
Note: For determining a gap, I use the cash price and not the futures, because they could be very different and I don't think futures gaps have the same drawing power as the cash gaps do...
Interesting. I looked at USO, examining the Gap Opening, which it usually does at the open.
Well, there is no 2nd gap on this USO chart. There is an island reversal on the 26th with a small double top that promptly sells off in the consecutive days, although it fills the downgap first.
For the rule you need 2 consecutive, same direction gaps. The consecutive part can be treated rather loosely, meaning there can be extra 1-2 days between the gaps. The more days between the gaps the less likely it is to get filled, the probability goes down...
For the rule you need 2 consecutive, same direction gaps. The consecutive part can be treated rather loosely, meaning there can be extra 1-2 days between the gaps. The more days between the gaps the less likely it is to get filled, the probability goes down...
Well, time to raise this thread from the dead again, because we had extraordinary 7 days. The markets had 5 consecutive downgaps in a row, relentlessly trying to fill the gap each day with more or less success. Then on day 6th we upgapped and like a good soldier, didn't leave and unfilled gap behind.
I am showing the action on the Nasdaq, because it is prettier in a way that the huge rally on Thursday actually closed 3 gaps! (The SPX downgap from the top on Nov 9th at 2594 is still unfilled)
So let's see the action with explanations:
1. On Nov 9th the markets downgap and although there is an effort for a gapfill, it stays unfilled. I will call it the Original Gap.
2. Next day another downgap and according to the rule, it get's filled on the same day.
3. Next day again, a downgap and although the probability of getting filled on the same day gets lower as we get away from the Original Gap, it gets filled on the same day.
4. On the 14th another downgap and because we are 4 days away from Original Gap, although it tries hard, but doesn't get filled. Now we have 2 unfilled gaps in a week.
5. On the 15th the 5th consecutive downgap occurs, and according to the rule it should get filled. Although it rallies hard (so going long would have made you money) it eventually fails.
I have to mention that there was an upgap from 3 weeks earlier and that got filled this day. I look at it as the hole sucking price down.
6. On the morning of the 16th we have 3 unfilled gaps left behind in a week and the markets are like an over stretched spring suddenly let go. They upgap huge and rally all day never looking back. In one day all 3 downgaps are filled on the Nasdaq!! (but only 2 on the SPX) This also creates an island reversal on the charts.
Crazy times... I posted a long call in the Ponies thread in the morning of the 15th when we reached that unfilled upgap level (not shown on this chart) from Oct 27th, 2560 on the SPX. The next day SPX hit 2590. (but still falling 4 points short to fill the Original Gap)
I am showing the action on the Nasdaq, because it is prettier in a way that the huge rally on Thursday actually closed 3 gaps! (The SPX downgap from the top on Nov 9th at 2594 is still unfilled)
So let's see the action with explanations:
1. On Nov 9th the markets downgap and although there is an effort for a gapfill, it stays unfilled. I will call it the Original Gap.
2. Next day another downgap and according to the rule, it get's filled on the same day.
3. Next day again, a downgap and although the probability of getting filled on the same day gets lower as we get away from the Original Gap, it gets filled on the same day.
4. On the 14th another downgap and because we are 4 days away from Original Gap, although it tries hard, but doesn't get filled. Now we have 2 unfilled gaps in a week.
5. On the 15th the 5th consecutive downgap occurs, and according to the rule it should get filled. Although it rallies hard (so going long would have made you money) it eventually fails.
I have to mention that there was an upgap from 3 weeks earlier and that got filled this day. I look at it as the hole sucking price down.
6. On the morning of the 16th we have 3 unfilled gaps left behind in a week and the markets are like an over stretched spring suddenly let go. They upgap huge and rally all day never looking back. In one day all 3 downgaps are filled on the Nasdaq!! (but only 2 on the SPX) This also creates an island reversal on the charts.
Crazy times... I posted a long call in the Ponies thread in the morning of the 15th when we reached that unfilled upgap level (not shown on this chart) from Oct 27th, 2560 on the SPX. The next day SPX hit 2590. (but still falling 4 points short to fill the Original Gap)
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Your thread says 2nd Gap, and you are stretching it to 5 gaps! Is that doubling down or what? Ever tested this theory in 2008?
For sure this many consecutive gaps hasn't been common. Maybe this is going to be the new normal. The original rule has been validated many times in the last 10 years, I just don't post it every time when it happens, after all I explained it how it works 10 years ago.
One explanation could be that the bull market finally has reached its top and finally trying to fall, but it is more of a slow, rolling over process instead of a giant sell off.
The Rule didn't work on the 15th (nothing is 100%), but this was a very strange week and if you went long in the morning, you still caught a nice rally. Anyhow you could back test it, I have been using this since I started this thread...