I've read the following on gap theory, but can't remember where.
1. There is a tendency for gaps up or gaps down to be refilled by retracement in the short term.
2. The reason for this short term tendency to fill gaps has been attributed to either
a)random walk -- will surely tend to refill gaps. However, mathematically, the probability of randomly filling an "upward gap" in a stock with an "alpha" greater than 0 (i.e., its price is rising over time) will tend to decrease over time. In other words, the longer the gap remains unfilled, the lower the probability of it ever being filled.
b)some studies have said that another reason gaps tend to be filled is that those who bought the stock after a gap up tend to be "weaker hands." They bought the stock just because it rose, so, if it starts falling, they are likely to bail out quickly, driving the stock down quickly through the gap.
3. All academic studies have shown that after a long period of time (see below for definition of "long") there is no particular tendency for gaps to be filled.
Now, for the definition of a "long time," and an explanation of why point number 3 above is true:
1. Every trading day a fraction of the "float" in a stock changes hands. For example, in AMD, on an average trading day 5 million shares change hands. Since the "float" in AMD is 111.8 million shares. [The remainder of this discussion will be for AMD only.]
2. On average, the publicly available shares (the "float") changes hands every 23 trading days which is a month.
3. Since "weak" hands, tend to trade more frequently, it is unlikely that there are any weak hands that bought the stock after the gap on 6-Mar-00 who are still holding the stocks. The gap from 42 to 46 occured five months ago. "Weak hands" tend to
a) take profits quickly and
b) trade more frequency than most folks
Therefore very few "weak hands" who might have bought the stock after the upward gap five months ago would still be holding the stock.
AMD's public float has turned over five times since the upward gap in March. This qualifies as an extremly long time ago in terms of "gap theory" so there is no particular reason that the gap of five months ago should ever be filled.
Petz |
