Technical Analysis Education: What are “Gaps” and How to Use Them
There are many, many technical indicators and tools used by traders to predict market price action to enhance marketing and trading income. One of those technical indicators is a “gap” on the daily price chart of vertical bars showing the high and low price traded for each day.
A gap is created on the daily price chart when:
1) The highest price of one trading day is lower than the lowest price for the next trading day
2) The lowest price of one trading day is higher than the highest price of the next trading day.
On Friday, 10 July 2020, December 2020 corn traded a low of $3.43¾.
On Monday, 13 July 2020, that contract traded a high $3.42.
Note the low on the 10th was 1¾ cents higher than the high the next business day, July 13th.
That left a gap on the chart:
The technical significance of a gap is that:
1) If the price is below the gap, the gap is an area of resistance, meaning the closer the price comes to the gap, progressively more sell orders will be encountered, “resisting” the uptrend of the price. The safest sell order is a price at the top of the gap, which is not likely to be filled the first time the price moves into the gap area.
2) If the price is above a gap, the gap is an area of support, meaning as the price declines toward the gap, progressively more “buy” orders will be encountered, providing “support” for the price. The safest buy order is at a price at the bottom of the gap, which is not likely to be filled the first time the price moves into the gap.
On August 13th, 2020 I had a client who wanted to sell December corn at $3.41½, a half cent below the bottom of the gap (rather aggressive sell order), but the high that day was only $3.40¾, so an order at $3.41½ could not have been filled. The settlement was $3.38¾.
On June 1, 2021, Spring Wheat gapped higher on the opening leaving a whopping 8½ cent gap.
On June 7th, September Spring Wheat was falling like rock from a new contract high of $8.45¾.
A client who wanted to get long (buy) spring wheat recognized that June 1st gap from $7.41½ to $7.50. He placed an order to buy in the gap at $7.42¼, just three-quarters of a cent from the bottom of the gap. It seemed like a good move at the time given the way the price was falling because rain was on the way for North Dakota and the Canadian Prairies.
On June 9th, the spring wheat price got deep into the gap, more than a dollar below the high made just two ago and rallied like a rocket to settle 27 cents above the low for that day.
The guy was a genius, right? Made $1,350 per contract, right? He was a genius, but, no, he did make $1,350! The low trade into that gap was to $7.42¾, a half cent above his buy order. Bummer!
Note the little box to the right on the Spring Wheat chart below. You can see the gap was almost filled, but not quite. The bottom of the gap was $7.41½. The buy order was at $7.42¼. The market traded into the gap that day down to $7.42¾. A small gap of 1¼ cents was not “filled” nor was the buy order because it was a three-quarters of a cent above the bottom of the 8½ cent gap, but a half cent below the low for the day.
A breakaway gap is caused by a strong price movement through major support or resistance resulting in a price trend change.
On January 24th, 2020, November soybeans moved below its 200 day moving average price. Nothing special about that. It had been obvious for weeks that was going to happen. A 200 day moving average is just that: the average price for the past 200 days. It could be the opening, high, low or settlement moving average price, which there can be a substantial technical indicator derived from plotting all of those lines, but that is for another day.
On August 12th, 2020, the USDA came out with a very bearish soybean S&D, increasing the carryout for the 2020 crop to a 50-day supply, up from a tight 36-day supply the month before. The crop was essentially made, the seasonal trend was down, harvest was 30 days away. The November bean price had finally gotten above $9.00, but the 200 day moving average was $9.02 that day. The price of beans had not been above the 200 day moving average since January 24th, before the crop was planted.
It was August 12th. The crop was made and the USDA said it was going to be best yielding soybean crop ever, resulting in a burdensome carryout. Five days later, November beans blew through that 200 day moving average with a two cent breakaway gap. A few days later, the price traded down to the 200-day average, it held and the price has not looked back since. It will probably be the fall of 2022 before we see bean futures below $9.00 again. With inflation ramping up here in 2021, we may never see November beans below $9.00 again. Don’t bet your farm on that. But do take a look at the chart with the breakaway gap:
A lot of farmers sold their 2020 beans in the days after that August 12th S&D. I had been saying for a year November 2020 beans would get to $10, but I had to face the facts after the August S&D: crop made, seasonal trend down, huge carryover with the 200-day moving average, a major technical resistance, just a very few cents above the price. I told clients to give up on $10 beans until maybe in 2021.
When beans had that breakaway gap on the 17th, all those sold beans should have been bought back with futures or calls, or bull spreads.
Once again, the market told us through technical language what it thought carryover was going to be and most of us were not listening or could not understand the language.
The USDA issued its June 2021 S&D yesterday. What happened to that 50-days’ worth of use carryover? USDA now says it will be an eleven-day supply, the tightest carryover ever since we quit baling soybeans for hay. The market told us with that breakaway gap last August 17th this huge rally was going to happen.
The USDA August 2020 Soybean Supply & Demand Projections (marketing year begins 1 Sept)
The USDA June 2021 Soybean Supply & Demand Projections: