Playing the gap is one of the most
powerful trading techniques you can employ, and it is particularly useful
for making a "quick buck," once in the morning. We call this the
Dumb Money Gap Down, or "DMGD." It is when a stock opens substantially lower than its previous close,
or plummets sharply soon after the opening bell.
The technique is based
on the fact that inexperienced ("dumb") investors will frequently
buy or sell stock before the market opens. If such pre-market action is to
the sell side, the stock will gap down, which means it will open below where
it closed in the previous session.
Although we refer to
stocks that gap down (open lower), a DMGD includes a stock that opens flat,
or even slightly higher, but quickly plummets during the first few minutes.
Whether this occurs right at the bell or shortly thereafter, the theory is
the same: the "dumb" money sold the stock.
Why
"DMGD" Works
The theory of the "DMGD"
is that no real professional would ever sell stock first thing in the morning
without a compelling reason to do so. Hence, any sharp action in either direction
is due to inexperienced traders. And, more often than not, the "smarter"
money frequently swoops in to drive it back up. Using proper timing, you can
usually catch the bounce and make substantial gains in only a few minutes.
Another reason that stocks
gap down sharply is that the less experienced traders and investors will overreact
to news, or to an analyst downgrade, etc. The interesting point about this
is that the DMGD strategy tends to work even if the stock is gapping down
for a "reason." More often than not, a reaction to a negative event
is overdone, sometimes blatantly so.
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