Trade Like an O'Neil Disciple: How We Made 18,000% in the Stock Market

5.10. DR. K'S LABORATORY: BUYING GAP-UPS IN LEADING STOCKS

There is nothing more alluring for a trader than a stock that is gapping up hugely on tremendous volume. Despite this, we tend to view gap-ups as being extended and hence do not have the confidence to buy them, even though they may very well be signaling that the stock having the gap-up is potentially a very powerful, big, winning stock. Sometimes big gap-up moves can occur as simple new-high base breakouts, and if the gap-up move is within 5 percent of the high in the base at any point, it is buyable on that basis alone. We see this in GameStop Corp. (GME) in Figure 5.39, which gaps up on August 23, 2007. Notice that GME had tried to break out earlier at the beginning of August but failed, pulling back and testing the lows of its base. This gives the base a sloppy look, but when it finally does break out of this base on a huge-volume gap-up move, the strong gap-up action entirely exonerates any questionable price/volume action within the base. This is one basic rule of gap-up breakouts—they negate or "exonerate" any negative or weak action in the base, such as the erratic, failed breakout of GME in Figure 5.39. That said, gap-ups should not be bought back if the stock is in a clear downtrend. GME in this example is, however, a simple gap-up situation that is easily determined as buyable since it is also a clean new-high base-breakout.

Figure 5.39. GameStop, Corp. (GME) daily chart, August 2007. A huge-volume gap-up base ...