There are several different types of gaps, but ultimately it can be considered a surge in buying, typically on large volumes, that causes a stock to open and close well above its prior day closing price. Gaps show there is strong interest in a stock and is typically news/announcement related. Depending on market conditions and the proximity of the gap to support and resistance, gaps can be bullish or bearish. Since buyers flooded the market on the "gap-up day," if momentum doesn't continue and the stocks weaken again, then many of those traders will quickly look for an exit. On the other hand, gaps place short-positions in a precarious position, and bulls feeling confident. If buying continues, a gap may be just the start of an even more significant upside move. These four stocks had recent significant gaps, but not all have a bullish outlook.
SEE: Technical Analysis: Support And Resistance
Barclays (NYSE:BCS) jumped more than 9% on Feb. 12, breaking out of a small band it had been trading in much of January and early February. The stock had been moving aggressively higher since July before moving laterally in the early part of 2013. The gap appears to show that the trend is still very strong in this stock, and has further potential upside. The sticking points are multiple levels of resistance between $20.75 and $22. If the stock can clear that resistance band in the coming weeks, the long-term outlook for the stock significantly improves as breaking through resistance levels is likely to attract more buyers. This stock was trading above $60 in 2008 though, so there are still a lot of investors who may have some fear and might be looking for any rally to thin their holdings. Therefore, if the gap up is erased, and especially if the stock drops below $18.20, look for at least a short-term decline to ensue.
Michael Kors (NYSE:KORS) has spent much of the time since its IPO in late 2011 moving in a choppy sideways fashion. Then a gap occurs, the stock moves up and a new choppy range develops. Whether this pattern repeats is yet to be seen. If the pattern continues, and the stock begins to move in a lateral channel once again, upside is limited based on the current price. The jump of nearly 9% on Feb. 12 likely exhausted much of the buying that is likely to be placed. It is also noteworthy that intraday the stock was up more than 13.5% from the prior close, and sold into the closing bell indicating that buying interest was already waning. Overall, the stock is in an uptrend and I see no reason to run from it now. Picking it up here is a bit pricey for me though, but between $58 and $54 I like it a bit more, with a stop in the $50 range. With that said, while this gap up could be the start of a strong wave higher in the stock, I think there are other plays out there, with a more defined trend, that warrant investment before Michael Kors.
Avon (NYSE:AVP) surged more than 20% on Feb. 12, placing it right in the middle of important support and resistance levels. The large gap up shows momentum may be turning in the down-trodden stock, which traded above $31 in May to below $14 in November. The real test is whether the stock can break above $24. Still a ways yet, it is hard to forecast a price move beyond that level as on the last two attempts in October 2011 and April 2012 the stock fell dramatically. There is a chance of about another 10% rise in the stock before facing this resistance level, with the potential for much larger gains if the level is exceeded. Therefore some may see the trade as worth the gamble, even at near $21 per share. Support is now at $18.50 and $17.50, so a stop can be placed just below either of these levels. I prefer to wait and see how the stock reacts after this big move. With major resistance overhead, the upside is vague, and waiting for a pullback that stays above $17.50 is likely to present a lower risk trade setup.
SEE: Support & Resistance Basics
Spirit AeroSystems (NYSE:SPR) jumped 5% on Feb. 12, but was up 10% intraday. The high point was $17.75, not far off the significant resistance level of $18 that stifled the stock back in early January. The gap higher placed the stock closer to a potential breakout, but until the price rallies through $18 I don't see much to get excited about. After a significant drop in October the stock has moved between $13.96 and $18, and this will continue until a breakout occurs. A rally above $18 gives an initial price target of $22, and since the breakout will have already occurred, the stop can be placed fairly close at $17. There is minor support at $15.80, if the stock can't rally and breaks this level look for it to head lower and test $14.
The Bottom Line
When a gap higher occurs it shows strong buying interest, but that doesn't always mean it is time to jump on board with everyone else. Consider the context of the support and resistance around the current price to determine if further upside is likely. The potential profit may not warrant the risk associated with paying the higher price. If the trend is strong though, gaps can alert you to stocks on the move. There are times when paying a much higher price than was available yesterday will pay off, as the gap is just the start of a larger move. No matter how your trade gaps, always manage your risk and be prepared for the volatility which may come your way.
Charts courtesy of stockcharts.com
At the time of writing, Cory Mitchell did not own any shares in any company mentioned in this article.