Gaps at the Top

Gaps at the Top Candlestick Charts

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The gap up that appears at the top of an uptrend is the one that provides ominous information. Remembering the mental state of most investors, the enthusiasm builds as the trend continues over a period of time. Each day the price continues up, the greater investors become convinced the price is going to go through the roof. The “talking heads” on the financial news stations start to show their prowess. They come up with a multitude of reasons why the price had already moved and will continue to move into the rosy future. With all this enthusiasm around, the stock price gaps up. Unfortunately, this is usually the top. Fortunately, Candlestick investors recognize it. They can put on exit strat­egies that will capture a good portion of the price move at the top. Consider the different possibilities that can happen when witnessing the gap up at the top of a sustained uptrend. Most of the time, the gap will represent the exhaustion of the trend, thus called an Exhaustion Gap. Or it could be the start of a Three Rising Windows formation, or big news such as a buy out or a huge contract announcement about to be announced.

What are the best ways to participate in any potential of higher prices, at the same time knowing that the probabilities are that the top is near? A few simple stop-loss procedures can allow you to comfortably let the price move and benefit from the maximum potential.

Hopefully, after a gap up is occurring, (the exuberance of an extended trend), a substantial gain is already realized in the position. The gap up is adding to an already big gain. Probabilities dictate that this is the top. However, there is the possibility of more gains.

Upon a slight to medium gap up, the Candlestick investor should put their stop at the close of the previous day. The thinking being that if the price gapped up in overbought conditions, and prices came back down through the close of the previous day, the buying was not sustained. If so, the ‘stop’ closed the posi­tion at the level of the highest closing price of that trend. The same rationale applied to the psychology of a gap down at a bottom of a trend can be applied equally well to the gap up at the top of a trend. Where do most investors buy? They buy when the confidence has finally built up, after the price has done well. When most investors feel safe that a price is doing well, that is usually the time to look for ‘sell’ signals.

The gap up after a strong run up is dearly indicative of the exuberant buying. When buying gets exuberant, the smart-money starts taking profits. Fig, 4-21, The Advanced Auto Parts Inc. chart, reveals the exuberance. Large candles, in the overbought stochastics conditions, reveal that investors are pil­ing into the stock. Finally a gap up becomes the first signal that the top may be near. This becomes more evident the following day when a Harami/Hanging Man signal appeared. Now there is the evidence of a gap up followed by a potential candlestick “sell” signal. The lower open the following day makes it more convincing that the top is here. Does a gap up at the top necessarily mean the ultimate top has occurred? Definitely not, however it produces a good indication that a top may be very near. It provides the investor with an alert to be ready to take profits and/or start shorting a position on the first signs of weakness.

Fig. 4-22, The Plantronics Inc. chart shows a Shooting Star after a gap up. The Shooting Star at the top of a trend alone would signify that the bears are mak­ing their presence known. The fact that it occurred after a gap up is more convincing. Exit strategies can be better formulated when knowing the prob­abilities indicate a reversal is occurring or about to occur. Each investor can prepare exit strategies that comfortably fit their investment nature. For ex­ample, upon seeing weakness the following day after the shooting star, half the position may have been closed out. The other half might have been closed out two or three days later as more candlestick sell signals appeared. A gap up at the top has historical indications that the majority of the uptrend is over. Hav­ing that knowledge allows an investor to better analyze and shift funds from a poor probability situation back into a high probability situation.