The second "GAP UP" in three sessions that has not been filled. Is it necessary to fill a gap? Is this a test of patience to the upside or has the train left the station? (October 15, 2002)
There is an adage in the market that gaps must be filled before further progress can be made. Think about what has recently been happening on the downside (before late last week): stocks would gap below support (50 day MVA, etc.) and sell lower. Then they would rally back up to fill the gap, testing the breach of support and then falling again. Whether the test came the next session or a week later, many times the gap was filled on the next rally phase in the continuing downtrend. Now we are looking at the other side. The Nasdaq made the big gap up Friday and then again Tuesday. We know the market cannot run up or sell forever; it has to come back and test some support or resistance. Oftentimes when this happens it works to fill the gap on a normal consolidation of the gains in the rally.
But what happens when there is a gap up that is not filled? Back in October 1998 there was a gap higher that remained unfilled until the September 2001 low. Did the market inexorably sell just to fill that gap? No, it was part of a much large market collapse after a historic run-up. It did not seek that gap, just sold through it as it went lower. And that is the key; the market does not seek a gap point just to fill it; it is something that can act as support on selling or it can just plow through it as the 1998 gap that was filled after the Nasdaq ran from roughly 1530 to 5000.
Thus there is really no reason the first gap must be filled. If this rally fizzles and it craters, it will be filled as the market heads lower to find a new low and try all over again. As in 1998, however, the market can continue to rally a long, long way without filling that gap. The Tuesday gap? It will most likely be filled at least partially in the pullback that is going to take place after such a strong run. That is the simply normal consolidation after a strong move and does not really in our opinion necessarily result from the gap. Strong moves, gaps or no, are followed by consolidation. Sometimes it is a full test, other times a partial test. If you wait for the complete fill of the gap during a strong upside trend, you could miss out on substantial upside moves.
As far as the train leaving the station, there were many institutions buying Tuesday as the market followed through on the rally that started Thursday. Follow through sessions set the stage for stronger advances but they do not guarantee the move will hold. It is a signal to start putting more money to work but you have to keep an eye on breakout stocks. You want to see good stocks breaking out (they are doing that now) and they must hold their gains when they perform those inevitable tests of the breakouts. If they crash back into the bases on high volume, that is a signal the rally is in trouble. This rally has set up well and is showing very solid indicators (sentiment, follow through internals, breakouts) early on. The first test is the Intel earnings news; the gap will try and fill here and we will know more if breakouts hold up and the market tests back on lower volume a few sessions and then rallies again on strong volume. It is a close enough imitation to a train leaving the station to warrant putting money to work on the good breakout stocks just as we have been doing all along as they formed up and started to move as this rally started.
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