Friday, November 16, 2012

Gaps - a trend followers' enemy

Along with non-trending, whipsawing markets, price gaps can cause massive damage not only to a traders' equity but also his morale and confidence in the system they employ.

I've shown a chart below of a US stock that up until today's open was in a clear downtrend, only for a huge gap up to occur.

Events such as these can and do happen., Possibly one of the most well known examples of the damage a gap up can cause occurred the day AFTER the October 1987 stock market crash, and trend followers (including Richard Dennis and the Turtles) suffered when, after overnight government intervention, Eurodollars (on which they held a short position) gapped up to price levels not seen for several months. Overnight, their profits for the year vanished.

So, next time you feel confident enough (or foolhardy) to increase your risk per trade beyond what would appear to be sensible levels, something like this may occur. You have been warned.

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