Gap Up close Scan (free Download)

The Gap Up Close scan is a scan I run in my ThinkOrSwim side bar along with several other scans. If the scan “triggers” for any stocks trading in the US stock market, the ticker symbol will be automatically added to the “Gap Up Close” watch list. I have that watch list linked to one of the charts displaying in my ThinkOrSwim platform layout. I can then click on a stock in the watch list and it will show the chart for that stock in the chart window that it is linked to.

This scan filters out low float/low volume stocks. This keeps the amount of “triggered” stocks down, and also eliminates stocks that are very hard to get in and out of due to lack of liquidity. What this scan is searching for are stock that have gapped up and then closed the gap on a daily chart. This is usually due to overnight news that has come out either at the end of the previous day or while the market was closed. A gap up is when the price of a stocks opens higher than the closing price of the previous day. The scan is obviously looking for a significantly higher opening price. Many stocks are not going to open at the exact price that they close at on the previous day. The gap has to be at least 1.5% for it to be statistically relevant. As mentioned previously, a significant gap-up or gap-down will usually occur due to an earnings report coming out after, or before, the opening bell. Or, due to compelling news that has come out while the market was closed (either after hours, or pre-market)

This scan is used to trigger stocks and create a watch list of “in-play” stocks. Once a ticker is on the watch list you will need to look at the chart and determine why it’s moving, where the price is it relation to its 52 week highs/lows, and many other factors, including what the overall market is doing. This scan trigger is NOT a signal to buy or short the stock… If only it were that easy. This watch list just gives you a sub-set of stocks to focus on, that are in-play for the day that they trigger.

A gap down tells you that many traders decided to buy the stock (go long) in the after hours session, or in the pre-market session. The volume when the market is closed is much lower than during regular market hours therefore relatively small buy or sell orders can create wild swings in price. A gap up is not only caused by traders buying in after hours sessions, but also by a pent-up demand to buy once the market opens. If the “Market Makers” (which is now actually just a computer program) “sees” a large volume of buy orders, it will raise the price to try to create sellers for those shares (basic principles of supply and demand).

As with all the ThinkOrSwim scans on this website, there is a lot of discretion involved on whether to take the trade, and in which direction. These are not auto-trading (green light – red light) scans, where the scan triggers and you automatically buy or sell. You need to watch the scan trigger many times, over many weeks, determine what caused the trigger, and then determine if there is a pattern to what the stock price does after the trigger most of the time. Of course it’s not going to the do same thing every time. But if you see a pattern in the stock price that happens 60%, 70%, 80% of the time, then you have an edge. Also, it is important to look at other factors, such as what caused the gap up and what type of stock this is (Is it highly traded? Is it a volatile stock? Is it highly shorted? Is it held by a lot of insiders/institutions/funds? etc, etc).

The way I will often trade this scan: I first determine the reason for the gap up. Secondly, I will figure out why I think people started to sell to close the gap. I need to determine if the gap close was caused by funds starting to reduce the size of their position, as well as, traders starting to take short positions. If this is the case, once the gap is closed, the buy orders may start to dry up. If the reason for the gap up is not a valid reason or is no longer valid, the stock will start to fall again. I will go SHORT only after I start to see weakness with volume. I will determine a target price based on the reason the gap up didn’t hold, previous resistance and volatility of the stock. I also always was a stop-out price based on the same factors as well as the size of the gap up.

The image at the top of this article shows an example of a trade set-up using this scan. DDS (Dillards) gapped up due to news. The new was that an activist investor (Snow Park) was urging Dillards to lease its real estate. There was an article out on Bloomberg news before the bell with headline, ““Dillard’s is essentially an underleveraged real estate company that’s masquerading as a low productivity retailer.” The article basically stated, Activist investor Snow Park Capital Partners has built a position in department-store chain Dillard’s Inc. and is planning to push for changes at the company, including unlocking the value of its real estate portfolio. This may have cause the stock to gap up and then continue to rise, but DDS is a retailer that was been beaten up, along with most other brick and mortar retailer.  They continue to miss their earning estimate quarter after quarter with no real catalyst for change in the foreseeable future. Lots of funds and individual investors are “under water” in the stock and are looking to get out or reduce their position any chance they can get.  They are trying to break even or get out with less of the loss, and move their capital into something that was more potential for future gains. The hope that Activist investors Snow Park Capital Partners thesis that they can pressure Dillards into unlocking the value of its real estate portfolio faded fairly quickly when people realized, Snow Park will be fairly ineffectual since the Dillards family owns all the voting stock. They will just ignored activist investors.  I gathers all this information from internet news sites and Twitter.

I determined that the news was nothing more than Snow Park Capital putting out PR to boost the stock price and investors were not buying it. There was no legitimate reason for the gap up. Once I saw some weakness, I opened a short position at around $78. My target price was $74. My stop out price was $79.50. This gave me over a a good risk/reward ratio. This is important! This means I can be wrong on more trades than you are right and still break even! Once the PPS hit $74, I closed the position and made about $3.50/per share profit (4.7% gain). I was short 200 shares and made approximately $700 profit in a bout 1 hour 15 minutes. $15,600 may seem like a large trade, but I was actually only risking $300 due to my tight stop. This was in fact a smaller size position for me since I didn’t think I had a big edge on this trade, it could have easily bounced and gone the other way and was not very confident in it. Usually when I take a full size position, I will scale out the close. closing 1/2 at one target price and the other 1/2 at a lower target price. There was ample time to get out at the target price. it hit the price several times, bouncing around, above and below it.

After this scan triggers, I will look at a number of factors to determine if there is a trade to take where I believe I have an edge. If I don’t believe I have an edge I will not take the trade. Never take a trade out of boredom or just following someone else into a trade. These are the things I look at after the scan triggers to determine if (a) there is a trade there and (b) if its a LONG of a SHORT:

1. News/Why the stock gapped up? With the Gap up close scan this is the most important aspect (look at: twitter, financial news websites)
2. Earnings. Often times a gap up is due to earnings. look at the earning report. did they beat their EPS target? By how much? Did they beat their Revenue target? Same-store-sales (if applicable)? Guidance (very important. The market moves on what is going to happen, not on what has already happened)? Often a stock will gap up due to a solid earning beat, only to drop later once it’s revealed on the conference call that the guidance is not great. Or, the future does not look so bright for some other reason. Is the move justified? Is it an over/under reaction? Is the price being manipulated by longs/shorts? (look at: earning report, twitter, financial news website)
3. What caused the gap close. Was it justified? Maybe the gap up was an overreaction, or a manipulation by longs?
4. Percentage of float short. This is important. It shows how many people don’t have faith in this company. Also, how many people need to cover (could create a squeeze). (look at: Yahoo finance, Google Finance, Finviz)
5. P/E ratio. Is the company under or over valued? (look at: Yahoo finance, Google Finance, Finviz)

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