The hardest days for me to trade are the days that the market and stocks in my watch list gap up big. I have tried several ways to play those, but often with not a lot of success. What is the method(s) that you use to play stocks that gap up big?

We ‘hate’ days where stocks gap open sharply to the upside when we are looking to enter into positions. With the market littered with failed rallies since March, each time the market gaps higher you almost have to expect a pullback. Today was another case in point: a gap higher just could not hang on as the Nasdaq rolled over and sold off. We have also seen gap up days that just continue to surge on up. That makes the gap up day so tough: it is very tempting to jump in and chase stocks higher when you see them running.

Knowing how stocks tend to act intraday helps in playing these days. One common theme we discuss in our plays is how stocks almost always like to test breakouts or breakdowns below support. If a stock races up in the morning or down, see if it comes back to where it opened the day or some other level of support (e.g., moving average, previous support or a resistance level it has taken out on the gap now becomes support. We often put in buy orders at that level to see if it tests it and moves back up. If the news causing the gap is strong, e.g., the company revises earnings estimates higher or announces some other longer term strong news, the gap often holds and we can pick up the position on the test.

Oftentimes a stock gaps higher and then fades, filling the gap to a certain extent. The time to buy upside positions is when the stock breaks back over the point where it gapped open, and preferably later in the day when we have a solid day building behind it. We sometimes play the bounce off the morning low, but that is risky, and we don’t do that unless the market is much stronger than it is now. We see many false gaps right now; we don’t chase them out of the gates, but we wait and see if the gap holds or if it is going to fold.