The New Science of Technical Analysis

Chapter 8

Gaps

A market psychologist will confirm the fact that emotions such as fear and greed play a significant part in determining price swings in the market. In fact, many market letter writers earn a living by measuring these sentiments and making recommendations based on their assessment of the collective opinions of the trading masses. There is a belief that in order to be successful in the market, a trader must buy when everyone is selling and sell when everyone is buying. In general, this is a valid observation because the consensus is generally wrong. Simply stated, logic dictates that as price moves higher the number of potential buyers is depleted until there remains, figuratively speaking, only the “last buyer” left to buy; consequently, by default, price declines. Conversely, as price declines, the number of prospective sellers diminishes until there remains only the “last seller” left to sell; consequently, by default, price advances. Just consider the roles of the specialists and the floor traders. Both provide liquidity to the markets by selling strength and by buying weakness. At the same time, they are always battling the trend and they make a comfortable living doing so. Although the most pronounced dislocations typically occur at the opening, these traders are afforded an advantage because they are responsible for setting the opening price. Opening price moves that exceed the previous day's close and fail to be filled by the close of trading are called either ...