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Dealing With Catastrophic Gaps

 
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JS



Joined: 19 Jul 2006
Posts: 8

PostPosted: Wed Dec 13, 2006 2:44 pm    Post subject: Dealing With Catastrophic Gaps Reply with quote

Hi. I'm still pretty much a novice trader and have been trying the candlestick method (according to the two books) to paper trade until I feel comfortable enough to start doing it for real. Anyway, I've been doing a lot of chart observing over the past few months or so, and one thing I've noticed, and that concerns me, is that not too infrequently I see stocks with massive downward gaps -- I'm talking 50% or more (NEOL is a good example from a few days ago). Many of the times in which I've noticed this, a stock will be in a nice and steady uptrend, no bearish candlestick patterns or anything, and then one day BAM! Since they are, as I said, not all that infrequent, I would have to think that some people here have had experience with them. So, my question, quite simply, is how you deal with them, or, even better, protect against them. Of course, even in paper trading I use stops, but I know that with these types of gaps they're useless. So, I'm hoping there's something else I haven't thought of. Any thoughts on the subject would be appreciated.

By the way, one thing I've noticed is that, at least in my observations, one industry that seems particularly susceptible to this scenario is the Biotech industry. The aforementioned NEOL is just one example of this -- I think that their plummet had something to do with the failure of trials of a brain tumor drug they're working on. So, I guess that's one preventative measure I can take -- just avoid Biotech stocks. Of course, though, that's not to say that I haven't seen this with stocks in other industries. It just seems like a disproportionate amount in Biotech.

-JS
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russjackel



Joined: 16 Sep 2005
Posts: 59
Location: niantic ct

PostPosted: Thu Dec 14, 2006 2:49 am    Post subject: Reply with quote

Very good observation JS and you are correct on all of your items. Biotechs are very volitile especially the small companys that only have one or a few candidates in the pipeline. They can also explode to the upside on approval of a drug and make you rich overnight. You are correct that a stop does you no good with a huge gap down and you just lose your investment. It is probably best to stay away from the biotechs or only invest a small amount in them because of the risk. You could also invest in a biotech mutual fund to spread the risk. I do not advise anyone to do so but I have made a few dollars trading stocks that have tanked on bad news because I find that a lot of times investors overdo it selling in a panic but I do not hold them just grab a quick profit and exit. The same thing can happen as far as a dramatic gap on an earnings report so a lot of traders will not hold a position when earnings report due. Hope this helps. Smile
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JS



Joined: 19 Jul 2006
Posts: 8

PostPosted: Thu Dec 14, 2006 3:15 pm    Post subject: Reply with quote

Hi Russjackel,

Yes, definitely helpful! Yes, it certainly also occurred to me that the gap scenario could go the other way, but I seem to be seeing it more in the downward direction, and really, there's too much risk involved to fit into the risk-reward profile I personally look for. Another possibility, I would think, for trading a Biotech stock that I'm bullish on is to buy a call option on it. That way, I don't lose nearly as much if their drug does fail, but can participate in the upside if it's a success.

By the way, I hope this isn't a really stupid question, but please keep in mind that I'm still pretty new to trading and have been concentrating on technical analysis. You mention the earnings report factor, and that is, in fact, another thing that I've noticed. Here's the question: is there any kind of central resource or anything that would tell me exactly when upcoming earnings reports are due for companies? Thanks again.

-JS
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drunnels



Joined: 09 Feb 2006
Posts: 23

PostPosted: Thu Dec 21, 2006 4:49 pm    Post subject: Reply with quote

This topic has come up before and someone suggested investing in ETFs as protection against these gaps. At the time I mentioned this was no guarantee since BBH (Biotech Holders) had had a massive selloff on Feb 28, 2005 when bad news was announced. Just to check since someone mentioned MF, I also checked the nav for BIPIX which is the ProFunds Ultra Biotech Fund. It also tanked 10% that day. So there is some protection with a MF or ETF, but it's still quite a factor if the fund is holding the newsworthy company.

A buddy of mine just today lost a wad in IAAC because he didn't check when earnings were due. He was up over 50%, but now only 15%.

I check earnings at Daily Graphs Online which is the premium service of Investor's Business Daily, but it costs $1000/yr. There used to be a website called earnings.com, but I don't know if they still exist or if they're still free. I bet you could find something at say Yahoo Finance or someplace like that.
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