On Dec. 19, 2011, a breakaway gap materialized, alerting soybean producers and traders alike to a sudden change in the price direction of the soybean market. In fact, this gap not only confirmed an end to the downward price spiral, but it marked the beginning of a counter-seasonal rally, with soybean prices rallying $1.65 per bushel over the next two months.
A gap is a price range within which no trading takes place. Normally, price activity during a single trading session will overlap part of the preceding session’s price range. When a gap is present, this does not occur. There are several types of gaps, all of which are beneficial in identifying price direction.
The breakaway gap develops at the completion point of many important chart formations. Once properly defined, the breakaway gap has a high degree of reliability in confirming a change in price direction.
The breakaway gap in the accompanying May 2012 soybean chart signaled an end to declining prices by gapping above the downtrending channel.
Market psychology: While the relative suddenness of a gap appears almost as an overnight experience, the conditions leading up to it may be the culmination of weeks, if not months, of human activity and psychological conditioning.
In the late stages of an entrenched downtrend, opinion is weighted very heavily to the short side of the market. Weeks of beneficial price movement tempt the shorts to expect lower prices.
Many shorts who would ordinarily consider taking profits simply hang on. They fear missing additional profits and are psychologically conditioned to expect lower prices. The market tends to be in the news and the publicity is most often bearish to substantiate the lower prices.
At this juncture, emotion is driving the speculative selling. Some sellers will short the market at any price and speculative longs are selling back their losing positions.
The bottom of the market will be marked by a single session in which an upside gap develops. By day’s end, the selling will be virtually exhausted. No matter how much prices gyrate during this session, the opening gap will not be completely filled.
In the following session, the market moves higher. This session’s price advance represents a radical departure from recent activity and generates nervousness on the part of shorts. The market’s sudden strength causes short covering, which pushes prices even higher. This in turn encourages fresh buying, thus ending the market’s decline.
The measuring gap (B) appears after a move has begun to accelerate. It is a sure sign of the heightened anxiety or excitement of traders who, waiting for an entry opportunity, see the market getting away from them and quite simply respond by buying.
This type of gap appears during a quick advance after prices have cleared away from a chart formation, such as the downtrending channel illustrated in the accompanying chart.
Often, this gap may be used to measure the ultimate extent of the move, as it appears at approximately the halfway point. If two or more measuring gaps materialize, the midpoint of the move will lie somewhere between the gaps.
Then there is the exhaustion gap (C). It occurs on the morning that the move in progress reaches its extreme price at the top of a move.
Upon first appearing, an exhaustion gap cannot be conclusively identified. The market’s behaviour in the days that follow provides confirmation. Should prices drop down to fill the gap after a strong advance has occurred, the gap is likely to be an exhaustion gap.
If a number of gaps have already appeared during a dynamic price move, the filling of the most recent one is a telltale sign of possible buying exhaustion.
Gaps are among the many chart formations which provide farmers with a valuable insight on price direction.
Send us your questions or comments about this article and chart.
— David Drozd is president and senior market analyst for Winnipeg-based Ag-Chieve Corp. The opinions expressed are those of the writer and are solely intended to assist readers with a better understanding of technical analysis. Visit Ag-Chieve online for information about grain marketing advisory services, or call us toll-free at 1-888-274-3138 for a free consultation.