Technical Analysis

Trends, Gaps and Probabilities

Recently, I wrote an article about trading and gambling. Specifically, how trading is the one form of speculation on the planet that allows you to stack the odds in your favor before putting any of your hard earned money at risk. That discussion was fine but now I want to look at how we qualify the difference between some higher probability opportunities and lower ones as knowing the difference is a key to success.

In the Extended Learning Track (XLT) ? Futures Trading and Forex Trading programs, a market situation we are often faced with is a gap. We use a simple checklist based on objective information to determine exactly what action to take (or not to take). The checklist helps us determine the probabilities, risk, and reward. Here is how some of it works:

Downtrend:

1) Gap up into an objective supply (resistance) level

In a downtrend, selling short on a gap higher into supply is likely the highest probability trading opportunity there is. This is because only your most novice trader would buy after a gap up in price, into a supply level, and in the context of a downtrend. Therefore, we want to be the seller to that buyer which means the odds are stacked in our favor. This type of gap is likely to get filled very quickly.

2) Gap down into an objective demand (support) level

One might think a gap down into demand is a buying opportunity right on the open of trading each time we see it. However, when we consider this action in a downtrend, this trading idea becomes a bit lower probability. While this gap is likely to fill and almost always does, it typically takes a bit longer than gap scenario #1.

Uptrend:

1) Gap up into an objective supply (resistance) level

This gap up into supply is a trading opportunity that we consider shorting as long as the risk is low and reward (target) is high. However, this is not one of our highest probability trading opportunities because we are shorting in the context of an uptrend. This gap will typically fill within the day or soon after but the higher probability gap trade to take in the context of an uptrend is scenario #2.

2) Gap down into an objective demand (support) level

In an uptrend, buying on a gap down into demand is likely the highest probability trading opportunity there is. This is because only your most novice trader would sell after a gap down in price, into a demand level, and in the context of an uptrend. Therefore, we want to be the buyer to that seller which means the odds are stacked in our favor. This type of gap is likely to get filled very quickly.

If you have not figured it out yet, the key factor in determining which gap scenario offers us the greatest odds is a direct function of identifying who is making the biggest mistake. Someone buying a gap up, into supply (resistance), and in the context of a downtrend is making a very big mistake which means they are buying when the odds are stacked against them. Therefore, we want to take the high probability trade and be the seller to that novice buyer. To summarize, the two highest probability gap trades are selling short when there is a gap up into supply in a downtrend and to buy on a gap down into demand in an uptrend. Of course, there is a little more to it than that when it comes to trading. With any of these scenarios, the risk must be low and the reward must be high and this is objectively determined off of the price chart (and a topic for another article).

Hope this was helpful. Have a good day.

Sam brings over 15 years experience of equities and futures trading which began when he was on the floor of the Chicago Mercantile Exchange. He has traded equities, futures, interest rate markets, forex, options, and commodities for his personal interests for years and has educated hundreds of traders and investors through seminars and daily advisory services both domestically and internationally. Sam has been involved in the markets since 1991 both on and off the floor of the Chicago Mercantile Exchange. He has served as the Director of Technical Research for two trading firms and regularly contributes articles to industry publications. Sam is known for his trading, technical research, and educational guidance.Points of interest:• Chicago Mercantile Exchange Floor• Author of Market Advisory Letters• Fund Manager/CTA• Speaker to Investment Groups, Universities, and Private Seminars• Contributing Author for Stocks, Futures, and Options Magazine, Active Trader Magazine, and Futures Magazine• Trading and Investment Conference Speaker

Sam brings over 15 years experience of equities and futures trading which began when he was on the floor of the Chicago Mercantile Exchange. He has tr...

egro1egro

Active member
123 7
It is amasing to see an article that has the word "probability" in its title andyet tells nothing about it, how to measure it or how to use it. It gives some rules that may work or not work and no tools for the reader to check where and when it works.

To me it is just a mumbo-jumbo with occassional sprinkle of "risk","reward", "profit", "probability" and without any specific helpful information.
It is extremely difficult and uncertain to define support/resistance. The whole concept is very subjective. On top of that you can say anything about probability of success of a gap or anything else. I can invert all the sentences in the article to make them have the opposite meaning and nobody, nobody (!) will be able to substantiate that I am wrong.
 

Cheaplogic

Newbie
2 0
I appreciate these articles, and look forward to reading them. And while this information may be useful to someone who started their journey this morning, it would be nice to see something useful to both newbies and those who could use something more of and "edge" than common sense. None the less thanks for the article T2W.
 

linuxrules

Newbie
6 1
To me it seems hard to determine whether we are in an uptrend or downtrend. Most often by the time you know the trend direction the trend is over. Once a trend line is broken, say in a downtrend, every trading book will tell you it is time to buy. Yet you really only know that this is true when you have watched the trend reverse. Now Sam tells us it is time to sell. That is a good idea if you bet on a trend continuation. And you may be right. But then again maybe you are not. Doesn't sound like high probability to me.
 

Baldwreck

Active member
118 6
I'm with egro1egro on this - there is no substance to the probability "theory " put forward here - it might be right - it might be wrong - in my opinion probably the weakest piece put on T2W ever - sorry!
 

Splitlink

Legendary member
10,850 1,232
The whole thing about the Black Swan is that it is an event that comes completely out of the blue. Therefore, it is irrelevant to know that they exist, because one is usually caught flat footed when it happens.

The only thing that one can do about them is to spread hedge one's bets and believe in Murphy's Law.

Split
 

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