Gaps - How I Trade Them

Hey everyone thanks for stopping by and reading my little blog. I want to talk about one of my favorite set-ups and that's gaps. One of the most uncertain and chaotic things that can happen in a stock is such a trading imbalance that it causes a gap up or down in the stock. As an individual this is a time were I have an edge over the big boys. The speed that I can get in and out of a stock allows me to trade these kind of setups without the risk that institutional traders would have to face in such a situation.
My favorite kind of gap is a bearish gap. I define a bearish gap as one that after gaping down is so weak that it cannot even make it back to the previous day low, intra-day. What this tells me is that something in this stock is really breaking down and the gap is just the beginning. I also look for ones that are up near there 52 week highs, if a stock gaps down after showing strenght for a long period, this further confirms to me that something has caused a major change and the trend has turned. After all of this I try to find the reason for the gap down, usually it will be a news item. Here you have to be very careful to make sure that whatever news brought it down is actually something that is going to keep this stock down. Earnings guidance is a good item to trade on but analyst downgrades is not. Once I have found a stock that meets my criteria I add it to my watch list and watch it, it may trade flat for a few days but if the stock starts to break down again this is were you need to get in. There are two ways to trade it, you can either go through the pain of selling the stock short and dealing with the uptick rules, or what I prefer is trading put options. If you are good with options then I would suggest options in this situation.

So that's how I trade gap downs. I will be back tomorrow with some tips on trading gap ups.
Thanks for reading and happy trading.