Gap Analysis and Moving Averages

Gaps are empty space on charts where no trading has occured.

There are 2 types of gaps:

1. Upward Gap: Where today’s low is greater than yesterday’s high, it results in Upward gap or rising gap or Bullish gap.

2. Downward Gap – where today’s high is lesser than yesterday’s low, it results in downward gap or falling gap or bearish gap.

Characteristics of Gaps

1. When prices open with a gap-up with respect to previous days close, it is a gap up opening & vice versa for gap down opening.
2. A gap-up opening need not result or translate into a rising gap and vice versa.
3. A gap occuring on a higher time frame chart would hold greater significance i.e. a weekly gap will hold more significance than a daily gap.
4. They also act as support & resistance.

Exhaustion of Gaps

This gap occurs at the end of the rally where volumes will be high and the gap will be accompanies with beairsh candle stick formation.

Note – Arally may even have no gaps and sometimes it can have more than 1 gap.

Island Reversal

When a group of bars are seperated by gap’s on both the sides it results in island reversal pattern.

When trend reverses from down to up it forms a bullish island reversals pattern.
– A bullish island reversal is an signal to buy with a stop loss as lowest of the island.

When trend reverses from up to down it forms a bearish island reversal pattern.
– A bearish island reversal is a signal to sell with a stop loss as high of island.

Moving Averages

There are two types of moving averages:

1. Simple Moving Averages ignores past data completely. SMAs are used for longer term periods.
   

Days	Closing
1	73
2	76
3	78
4	80
5	79
SUM TOTAL	386
5 DAY DMA	77.2

2. Exponential Moving Averages – these do not completely ignore past data. EMAs are used for short term periods.

Formula
Exp Factor = 2/(n+1) where n = no.of days
EMA = (Closing – Previous EMA)*Exp Factor + Previous EMA

Days	Closing	EMA
1	73
2	76	73.99
3	78	74.65
4	80	75.31
5	79	74.98

Characteristics of Simple Moving Averages

1. They are one of the most simple yet effective tool of technical analysis. They smoothen out random small fluctuation in price and thereby make decision making easy.
2. Moving averages are very good trend identifying devices.
   a. Short term trend 21 DMA / 34 DMA
   b. Medium tern trend 55 DMA / 89 DMA
   c. Long term trend 144 DMA / 234 DMA
3. Moving avergaes are very good trend following devices in a trending market
4. They are laggards
5. They are like curved trend lines superimposed on charts
6. It provides dynamic suport and resistance
7. They are used for generating buy and sell signals
8. Moving average when breached reverse their roles
9. Higher period moving averages are more reliable

Crossover of Moving Averages

Double Crossover – when small moving averages cuts higher moving average from below a buy signal is generated and vice versa for sell

Pairs used for trading
3 & 15 EMA
5 & 13 EMA
5 & 20 EMA
5 & 21 EMA
7 & 13 EMA
7 & 21 EMA
13 & 34 EMA