April 11, 2024
Gap trading is explained in this article. How to play gap downs is explained with chart examples

Gap downs in Trading – What should I do when my stock is GAPPING DOWN?

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Hi all !! Hope you are doing well. This time I am going to discuss an interesting topic. If you are in the stock market for a quite decent time by now you would have been familiar with Gap Ups and Gap downs in trading.

While Gap up defines the underlying strength in the stock Gap downs define weakness.

Now when I say gap down I don’t mean 1-2% gaps that occur randomly on charts. 1-2% Gaps either up or down does not signify anything (at least to me). I don’t give them too much importance. However, when gaps occur more than 3-4% then that signifies some serious weakness in the stock.

Such gap downs should never be ignored and if you are in that stock, you should move them immediately to sell the watchlist. Your stops should be tightened. At least your position size should be reduced.

In this article I will explain with examples, how gap downs look like in real market times and how one can save themselves from getting beaten out.

Run Away GAPS:

Common theory is that gaps will always be filled. But, it is not always the case. It depends on the demand and supply criteria for that particular stock and also the broader market condition. Some gaps particularly on the downside don’t get filled up (at least immediately). 

These GAP Downs that run far away from that gaping point are called RUNAWAY GAPS.

Runaway gaps can occur either on upside or downside. The purpose of this article is about gap down stocks. So I will stick to it now. Runaway gaps may range from 4-20% or even more. Higher the gap down, the more significant the weakness.

See the image below:

See the gap down of about 5.5% leading to a single day fall of more than 12%. Also note the volume increase and RS in the negative zone already.

GAP DOWN REASONS:

Some gap downs occur on the earnings report, some on bad news, some due to some restrictions / Actions by SEBI. But, as a positional trader the reason should never matter to you. For, initiating a position you can rely on stories / Fundamentals / Earnings etc., But to exit a position, kindly I repeat KINDLY never rely on any news, good fundamentals, Good earnings etc., You can always re enter if the stock shows up in strength again.

No one is going to stop you. If the stock has gapped down significantly. That’s it exit the trade. KEEP IT SIMPLE. That too if the stock gaps down below 50 DMA, it is a “clear” “clear” sell signal. Don’t cling on to the position.

If you are proven wrong the stock will form a base and will give a fresh entry. It will show positive price action. Then enter.

Now, see the chart below:

The chart is of POLYCAB INDIA. 

Gap downs in trading

Now, kindly don’t think that the chart is coming up. It will take a long long time before the stock starts moving up. It has just filled the gap. Structure takes time to form. Such a fall around 22% in a single day is not common. Even if the stock starts running up from tomorrow and reaches an all time high in a week, don’t worry. We have many stocks to look into.

Why to look into shady things, when the options are plenty. Bottom-line, exit and delete from your watchlist or keep in separate watchlist just for analysis.

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Gap down without any reason:

Sometimes, the reason may be trivial. You really can’t say what made the stock fall. Even then, you should consider exiting the stock. 

See the stock below: TRIVENI. After the fall the stock is in range for three months now. Many good stocks have broken out in meantime and have done extraordinarily well. Why waste your time on this. A Leader / multibagger will never show these symptoms. 

Gap downs in trading

My trade example:

Below is my own trade example:

I was more than 50% profit in this trade and convinced by the strength of the stock I even added more. The stock plummeted in days to come and when it gapped down I exited the entire position. 

No second thinking. No looking for reasons. My profit of 50% came down to a mere 18%.

Devastating. But if I had not exited and stayed with it, I would have been in a loss of (-10%) at one point and now not even in the breakeven level. I would have been a bigger fool to reduce a 50% profitable position to a loss making position.

Drawdown control is the single thing you should always think of. Read my article on “UNDERSTANDING DRAWDOWNS IN IT’S TRUE SENSE”.

Gap downs in trading

Gap down that can be considered:

Though I have shown you the examples of poor strength of stocks that are gapping down, one exception that can be entertained (Though I don’t recommend) are the stocks that gap down above or at  50 DMA and start forming a good base after the price action. Particularly when these stocks gaps down due to the earnings report.

Below are two current examples: 

Kindly note that these stocks are not for recommendation. I am not SEBI registered. Don’t ever trade these stocks based on my writings. 

One is ANGEL ONE:

Gap downs in trading

Another stock is AMBER:

Gap downs in trading

KEY TAKEAWAYS:

  • Gap down shows weakness of the stock.
  • If the gap down is more than 4%, then its significance increases.
  • Gap downs that occur below 50 DMA for whatever reason is a BIG NO NO. Exit immediately.
  • One can avoid severe disasters by following this rule. Recent example was PAYTM. I had written an article on how one could have traded the stock. Read it.
  • Gaps that occur above 50 DMA can be a shake out at times, but still why do you want to be in a stock that shows weakness?

I occasionally publish both my winning and losing trades as a journal. You can look into it, if it helps.

Consider subscribing to my newsletters, if you like my writings. Thank you !!! 

Happy Investing !!!

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