Frequently Asked Questions

Market Lab Report
What if a stock you own gaps down?

Gap downs of a sizeable percentage relative to the overall chart on high volume are a huge red flag. Usually, most such gap downs should be sold. If the stock suffered a major gap down of greater than 15%, the psychological tendency is to want to hold the position instead of taking such a huge loss. But my studies have shown that such stocks should be sold, usually at the opening of the day of the gap down.


That said, if you cant get yourself to sell the stock on that first gap down day, do sell it if, in subsequent trading days, it breaks the low of the gap down day.


If the gap down is less serious, you might sell none or part of the position then wait to see how the stock behaves during the trading day. A few stocks may finish gap down days at the high end of their trading range. Watch price/volume action in the ensuing days to ensure the stock does not violate your sell rules.


On gap downs that occur after an earnings announcement, the success rate of pocket pivots going into earnings depends in some measure on price/volume action leading up to period just before the earnings announcement. If the price/volume is appreciably large for the bigger capped stocks, this is a good clue. If the stock finishes up on the day on huge volume just before earnings are announced, the odds are with you that they will surprise to the upside. We have seen this action in many of the big names over the years such as AAPL, BIDU, GOOG, etc. Note that since volume volatility tends to be greater for smaller cap stocks, and such stocks are more susceptible to false rumor mongering, there is more risk in such stocks so as we say, position size accordingly. KRA and PPO would fall under this category (as of 11/4/10). They look fine and have strong fundamentals, then unfortunately disappoint. This market (as of 11/4/10) has been best led by the bigger capped names, with the occasional fundamentally strong smaller cap that also does well.


As we say, when you hold stocks going into earnings, you need to size your position according to your risk. If you take a 10% position and the stock tanks 20%, that's going to affect your portfolio 2%. Not a big deal. There is nothing to be learned other than if you went and plunged in on a pocket pivot going into earnings, you better think twice next time about your position sizing. Blind faith is not an investment strategy.

Published: Oct 19 2010