Gap Stock Trading Strategies
Stock gaps provide opportunities for investors. A stock gap is when a stock opens either significantly higher or lower than the price at which it closed the previous trading day. There are differing definitions as to what magnitude of a price move constitutes a gap. The most common criterion for a gap up is when the stock opens higher than the previous day's highest price. The common criterion for a gap down is when the stock opens lower than the previous day's lowest price. Traders and investors can profit from both gaps up and gaps down in a stock price.
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Gap Up Trading Strategies
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A stock typically gaps up when there is positive news about the company. A stock analyst may have upgraded his forecast for the stock's performance. The company may have released quarterly earnings that beat investors' expectations, or the firm could be merging with another company.
It's important for an investor to understand the reason a stock gaps higher. He also must analyze the stock's price movement and determine if it is warranted.
After this, the investor has several options for trading. If he believes that the stock price will continue to rally for the short term he can buy the stock as a short-term investment. His goal is to ride the momentum of the stock price and make a quick profit. The investor may not necessarily believe that the fundamentals of the company have changed dramatically due to the breaking news, but he believes that other investors will propel the price of the stock higher in the short term.
If the investor believes that the news changes the underlying fundamentals of the company for the better he can buy the stock with the intention of holding it long term. As an example, if a company announces that it is releasing a new and groundbreaking product, the investor may view this as a long-term benefit for the company and decide to buy the stock as a long-term investment.
The investor can also sell short a stock that gaps higher when the market opens. Many times stocks gap up on rumors or insignificant news. Investors get caught up in the excitement and bid the stock price up. A smart investor will understand that the gap may be nothing more than other investors trading on their emotions, and after the initial euphoria wears off the stock will most likely trade lower. When an investor sells a stock short he is betting that the stock price will decline and he will profit as the stock price falls.
Gap Down Trading Strategies
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Just like when a stock gaps up, an investor must also understand and analyze the reasons why a stock gaps down. After understanding the reason for the gap down an investor has a few trading options.
If he believes the breaking news will not have any real long term impact on the overall company but thinks investors will continue to punish the stock in the short term he can sell the stock short for a day trade or a short-term trade. The investor will ride the stock's downward momentum and profit as the stock declines. When the price of the stock begins to bottom out and it starts to increase in value, the investor will buy back the short shares to close out his short-term position.
If the investor thinks that the news will have a negative and long-term impact on the company's fundamentals then he can sell the stock short and hold the short position for the long term. The investor will use the negative news to initiate a long-term short position to profit from the company's deteriorating prospects.
The investor can also buy the shares of a stock that gaps down. He will do this when he believes that other investors are overreacting to the news and that the stock price will recover. The investor is betting that others will soon see that the news does not warrant such a low stock price and the stock price will begin to increase. As the stock price recovers the investor will profit. -
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