Mind the Gap

You probably have heard about “gaps” in trading. These gaps can be defined as jumps, or empty spaces, in the price formation of a financial asset. In other words, these are sudden changes in prices, like a hiccup.

kristopher-roller-320077-unsplash.jpgFor example, if the price of an ounce of gold, suddenly changed from $1,230 to $1,250, without registering a trade in between, a $20 gap would have occurred.

Some theories suggest that these gaps can signal: the beginning of a trends or breakouts, the exhaustion of a trend, or they simply just happen.

One of the most controversial theories regarding gaps holds that:

“all gaps are eventually filled”.

What generates these gaps?

Surely you have heard the phrase, the results of certain company were below the market estimates, or analysts’ consensus. Earnings’ season tends to trigger these anomalies.

Let’s start with two basic assumptions

1) Markets react accordingly to expectations. If a company grows, but less than expected, the reaction will not necessarily be positive.

2) Markets tend to overreact, both upwards and downwards.

With this, we can understand the excitement that it can generate in investors when a good report is released. Hence, strong appetite to jump into such a stock can make investors want to buy shares at prices as high as 345 dollars as soon as the stock begin trading, instead of taking as reference the 326 dollars closing price of the previous session, thus leaving a gap.

This exact example happened to Tesla’s shares back in August 2017, where a net loss lower than expected during the second quarter exalted the appetite of investors, generating a 4.9 percent jump in the shares overnight. By September 2017, the shares had reached 389 dollars, however, towards the end of October the rule was fulfilled and “the gap was closed” when the price fell to 325.84 dollars on October 25.

Once again in November 2017 we witnessed Tesla’s shares acting in the opposite way, leaving a gap on the downside, after falling hard. After reporting third-quarter figures below expectations, the shares opened on November 2 at $300 compared to a close of $320 the previous day. This time around, it only took 11 sessions for the price to recover and close the gap.

Have you identified further gaps in Tesla’s shares?

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