1296 0907 Price Gaps

HOW TO TRADE
the
Highest-Probability
Opportunities:
PRICE GAPS
EWI eBook
How to Trade the Highest-Probability Opportunities:

Price Gaps
By Jeffrey Kennedy, Elliott Wave International
Chapter 1 — Price Gaps Defined 2

Chapter 1 — Price Gaps Defined 2
Chapter 2 — The Importance of Price Gaps 8
Chapter 2 — The Importance of Price Gaps 8
Chapter 3 — How Price Gaps Relate to Technical Analysis and the Wave Principle 13
Chapter 3 — How Price Gaps Relate to Technical Analysis and the Wave Principle 13
Chapter 4 — The Gap Breakout Level 16
Chapter 4 — The Gap Breakout Level 16
Chapter 5 — Price Gap Trade Setups 30
Chapter 5 — Price Gap Trade Setups 30
Chapter 6 — Questions and Answers 38

Chapter 6 — Questions and Answers 38
Introduction
In this course, I will discuss price gaps and their importance with respect to the Wave Principle. The main point
I would like to make is that price gaps offer much information that is useful to the active trader — more than is
currently thought. While many books on technical analysis supply only limited information on price gaps, I will
show you that price gaps deserve much more attention, from both an analytical and a trading perspective.
Jeffrey Kennedy
Editor of Futures Junctures, Elliott Wave International’s
premier commodities forecasting service
Editor’s note: This webinar was originally presented live online on June 24, 2008.
How to Trade the Highest-Probability Opportunities: Price Gaps 1

© 2010 Elliott Wave International — www.elliottwave.com
Chapter 1
Price Gaps Defined
A price gap occurs when securities or commodity prices move significantly from one trading session to an-
other so that their trading ranges do not overlap. I call this kind of price gap a hard gap. But I also recognize
a soft gap, in which the closing price of the previous session does not fall within the trading range of the
current bar.
Figure 1-1
More specifically, a hard gap, illustrated
on the left in Figure 1-1, occurs when the
range of the current bar does not include
the range of the previous bar, leaving a
space between the two bars. The blank
space between the two price bars makes
it easy to see the gap on a price chart.
A soft gap, illustrated on the right,

doesn’t appear to have a space between
the two bars when taken at a glance,
but upon closer examination, you real-
ize that the close of the previous bar is
not included in the range of the current
bar. It’s still a gap, but it’s not as easy
to see as a hard gap. Let’s take a look at
some examples showing the difference
between the two.
Figure 1-2
Note the easy-to-spot hard gap that ap-
pears as a space on this weekly price
chart of Coffee.

Chapter 1 — Price Gaps Defined
Figure 1-3
These two hard gaps on this 60-minute
price chart of Soybeans illustrate the
traditional definition of a price gap. Price
gaps occur in just about every financial
market.
Figure 1-4
Here is a price gap on the 60-minute
chart of an actual individual stock —
Sepracor (formerly Nasdaq: SEPR).

Figure 1-5
Now take a look at a price gap that occurred
on its monthly price chart.
Figures 1-6 and 1-7

These two charts portray examples of hard
price gaps in daily Intel (Nasdaq: INTC) and
on the five-minute E-mini S&P 500, respec-
tively. Taken together, these six charts show
that price gaps can occur on any time frame
and in any market.

Figure 1-8
While large spaces clearly identify hard
gaps, it’s more difficult to decipher soft
gaps. Figure 1-8 uses a program that I
wrote to pinpoint where hard and soft
price gaps occur. The green arrows indi-
cate bullish hard gaps up, the red arrows
indicate bearish hard gaps down, and the
green and red dots denote soft gaps.
Figure 1-9
Here’s a close-up to allow you to study
a few enlarged soft gaps. So why do I
bother to distinguish between hard and
soft gaps? Let me show you in detail how
useful it can be to do so.

Figure 1-10
This monthly price chart of the Dow
reveals that while hard price gaps are
absent, the soft gaps identified by the
program portray significant levels of
support, resistance, and trading oppor-
tunities.
Figure 1-11
This Gold chart reinforces the impor-
tance of differentiating between hard
gaps and soft gaps, as soft gaps dot the
entire monthly price chart, yet hard gaps
are absent.

Figure 1-12
Similarly, this weekly stock chart con-
tained only one hard price gap (circled)
in price action spanning a period of more
than one-and-a-half years. However,
we can see 15 soft gaps that point out
other significant price levels. Thus, it is
important to label the two different kinds
of price gaps, because if hard gaps don’t
show up, soft gaps can provide useful
information to those who seek out high-
probability trading opportunities.

Chapter 2
The Importance of Price Gaps
Why are price gaps important for traders to understand? I frequently discuss this simple but critical answer in
Daily Futures Junctures and Monthly Futures Junctures, two of the publications I edit. Price gaps are important,
because they act as support and resistance for the market. They also often act like magnets, first attracting and
then repelling prices.
Figure 2-1
This combined sessions chart of July
Soybeans (with soft-gap identification
removed) shows two price gaps on the
left-hand side of the chart that act like
magnets. First, they attract prices down
to the blue horizontal lines (support) and
then repel them in a price reversal.
Figure 2-2
Moving forward in time on this same
Soybeans chart, we come to a bearish
gap to the downside followed by two
bullish gaps to the upside. Again, the
price gaps clearly identify significant
levels of support and resistance (marked
by the blue horizontal lines). For exam-
ple, the bearish price gap in red identifies
key support for the April sell-off, and the
top green price gap provides a nice shelf
of support for the pullback in May and
subsequent rally to the upside.
Ultimately, price gaps are important
because they act as psychological mark-
ers. What do I mean by that? Let me
explain with a short anecdote. Three or
four years ago, as I drove through an
intersection without paying much at-
tention to my surroundings, I had a car
accident. Now, whenever I drive through
that intersection, I always remember that
wreck; the intersection is a psychological
marker for me.

Chapter 2 — The Importance of Price Gaps
Similarly, when prices gap, they leave behind psychological markers that the market remembers. For example,
at the arrows in Figure 2-2, a number of people were happy because they were long Soybeans, and the market
went their way. They will thus remember that moment fondly. Others were short, and the market did not go
their way. They will remember that day as one of their worst trading days. Since price gaps become imprinted
in your mind, they are critically important to understand in regard to your own analysis.
Figure 2-3
This Cocoa chart shows another example
of price gaps acting like magnets. The
pair of price gaps on the left of the chart
(indicated by the green arrows) provided
excellent resistance for the move up that
began in April, while the bearish gap
(red arrow) provided a solid shelf of
support as the market came back down
and eventually was repelled to bounce
back up.
Figure 2-4
Now that you have seen evidence of
the importance of hard price gaps, let’s
see whether soft gaps can provide use-
ful information, too. I ran my program
that identifies soft gaps on this weekly
chart of Wheat. Note that the soft gap
marked by the blue line extending from it
provided support for the two underlined
pullbacks. Although there is more noise
with soft gaps, simply because there are
more of them than there are hard gaps,
they can still provide solid information
about where prices are headed.

Figure 2-5
Price gaps apply to all markets and
time frames. So, for example, here is a
60-minute combined sessions price chart
of Sugar. As you can see from the ex-
tended blue lines, the market traveled up
and “closed the price gap” (as traditional
technical analysts would say), which
then acted as resistance, prompting a
pullback. In addition, the circled bearish
price gaps with the extended red lines
provided support as the market pulled
back. Look what happened to the market
overall: It went up and was attracted to
the recent price gaps, and then it pulled
back into support provided by the earlier
price gaps.
This chart illustrates an important lesson: If you see a price gap, draw a horizontal line on your price chart and
leave it there, because it will often become significant and play a part in your analysis at some point.
Figure 2-6
Notice the interesting price gap forma-
tions in the 30-minute E-mini chart in
Figure 2-6. The red price gap in the
middle of the chart provided resistance
to the push up, while the green price gap
lent support for the turn back up.

Figure 2-7
Here’s a stock chart of Verizon (NYSE:
VZ) that summarizes what we’ve dis-
cussed in this section. The chart looks
like a bloody mess, doesn’t it? With
so many hard gap and soft gap labels,
you may wonder which ones are sig-
nificant.
Figure 2-8
To clarify this chaotic picture, let’s begin
at the high and work through each of
the individual moves within the sell-off.
Verizon tops in May, travels down to
supportive price gap number 1, and then
turns back up to encounter resistance
at soft gap number 2. Once prices hit
resistance, they sell off and close hard
gap number 3. Next, the market turns
back up and finds resistance at soft gap
number 4, falls to the downside to soft
gap number 5, and turns back up to
resistance at soft gap number 6. Prices
then sell off and encounter a small one-
day bounce to close soft gap number 7,
and finally push lower in April to close
gap number 8.
All these moves clearly depict a congestion phase of the market, because there’s no real trend, as prices simply
travel sideways. Despite the massive number of price gaps, there is a method to the madness.
To actually employ price-gap analysis in your traditional studies of price charts, you must use an appropriate
indicator. In this choppy market, the most appropriate indicator would be oscillators – such as stochastics or
RSI. However, if it were a trending market, you would use a different aspect of price-gap analysis and a different
indicator, such as a MACD or moving averages. Using an oscillator (perhaps a slow stochastic) with this gap
analysis could have allowed a short-term trader or a day trader to catch many of the swings in this market.

Which price gaps are important when there are so many of them? I believe that all price gaps are significant,
yet hard gaps hold a bit more weight than soft gaps, and price gaps that occur in electronic or combined ses-
sions trading are more important than those that occur in pit trading. Let’s see why by comparing two Soybeans
charts, one based on daily pit trading, the other based on combined sessions.
Figure 2-9
As you know, we’re moving toward a
global economy where you can trade any
financial market anywhere in the world
24 hours a day. Here is a chart of Soy-
beans pit trading. Many of the price gaps,
which result from overnight or electronic
trading, are of little importance, because
the chart displays the transition from
one day to the next day in the pit as the
world turns.
Figure 2-10
In contrast, the Soybeans combined
sessions chart in Figure 2-10 smoothes
out the abrupt ups and downs of the pit
trading chart by presenting the entirety
of the trading, which eliminates many
of the noisy gaps and identifies critical
levels. Notice that by using the combined
sessions version of Soybeans, the chart
displays only three price gaps as opposed
to 16 on the pit trading price chart.

Chapter 3
How Price Gaps Relate to Technical Analysis and the Wave Principle
Now, let’s briefly look at how price gaps relate to traditional technical analysis (you can find more detail in
any book on technical analysis) and then how they relate to the Wave Principle.
Figure 3-1
This Intel price chart (Nasdaq: INTC)
demonstrates the four types of price gaps
in traditional technical analysis: the com-
mon gap, breakaway gap, acceleration
gap and exhaustion gap. The first type
— the common gap (circled) — occurs
at tops, bottoms and congestion phases.
Although traditional technicians believe
that there’s little forecasting value in this
type of price gap, I think that all price
gaps are important.
Figure 3-2
According to traditional technical analy-
sis, the gap near the blue line at the top
of this enlarged version of the Intel
chart is considered to be a breakaway
gap, because it occurs on the heels of a
congestion period.
The second blue line is an example of

an acceleration gap, which is some-
times referred to as a continuation or
measuring gap. It holds a special place
in forecasting, because it tends to mark
the midpoint of a move (hence the name,
measuring gap).

Chapter 3 — How Price Gaps Relate to Technical Analysis and the Wave Principle
Figure 3-3
Lastly, the gap marked by the lower blue
line is an exhaustion gap, which typi-
cally occurs in the very late stages of an
impulsive move, either to the upside or
downside.
Figure 3-4
An island reversal is another common,
traditional chart pattern used by old-
school technicians. As you can see in this
Verizon price chart (NYSE: VZ), prices
gapped to the downside and then gapped
to the upside in a period of days. This
hard gap down followed by a hard gap
up is an island reversal. In this case, it
signaled a bottom, and prices did indeed
advance thereafter.

Chapter 3 — How Price Gaps Relate to Technical Analysis and the Wave Principle
Figure 3-5
Here is a near-textbook example of an
island reversal on a 60-minute chart of
Live Cattle. Prices gapped down and
then gapped up, leading to a rally.
Figure 3-6
Now, let’s move on to how price gaps
relate to the Wave Principle. Those of
you familiar with the Wave Principle
know that prices travel the farthest in
the shortest amount of time in a motive
or impulse wave (waves 1, 3, and 5).
One way they accomplish this speedy
travel is by gapping to either the upside
or the downside. One trick to zero in on
a correct wave count is to keep in mind
that price gaps tend to occur in the wave-
three position as shown by the figure on
the left side of this illustration.
In the right-side figure, I’ve marked an
entire five-wave move, including the
subdivisions and the traditional defini-
tion of price gaps. Wave 3 of 1 holds a
breakaway gap, wave 3 of 3 includes an
acceleration gap, and wave 3 of 5 con-
tains an exhaustion gap.
Exhaustion gaps tend to be closed by subsequent price movements. After wave 5 ends, prices would come
down in wave A, move up in wave B, and come back down in wave C to the previous fourth wave, thereby
closing the gap. This, then, illustrates how to use price gaps to identify third waves or impulsive structures
when using the Wave Principle.

Chapter 4
The Gap Breakout Level
Even though we now know where the different kinds of price gaps can appear in an Elliott wave pattern, there’s
still a basic question to answer: Once prices gap, will they continue in the same direction or change direction?
A technique that I developed can help to answer that question. It’s called the gap breakout level.
Figure 4-1
The best way to understand how my
gap breakout level technique works is
to use it on the weekly Coffee chart in
Figure 4-1. To determine the breakout
level, simply measure the length of the
bar preceding the price gap and add that
amount to the top of the bar following the
gap. This new level (marked by the dark
blue horizontal line) is what I consider
to be the breakout level, and we mark it
on the chart as the 1.000 level.
If prices can decisively penetrate this gap
breakout level in subsequent bars, the
move will continue in the same direction.
However, if prices stall, as they did here,
then a retracement will occur. Either the
market will travel sideways for a period
of time or the market will decline in an
attempt to close the gap.
Figure 4-2
Here is an image to clarify this infor-
mation. To determine the gap breakout
level, measure the distance from the low
to the high of the bar preceding the gap
and add it to the high of the move follow-
ing the gap. If prices travel through the
gap breakout level, but can’t decisively
close above it, odds are that the market
will decline.

Chapter 4 — The Gap Breakout Level
Figure 4-3
On the other hand, if prices decisively
penetrate this level (as shown in Fig-
ure 4-3), then this gap is probably a
breakaway or acceleration gap, and the
market will continue higher. This simple
technique allows you to differentiate
among common gaps, breakaway gaps,
acceleration gaps and exhaustion gaps.
Figure 4-4
Now, let’s put this technique into practice
on the daily chart of Johnson & Johnson
(NYSE: JNJ) in Figure 4-4. As you
can see, prices penetrated the breakout
level (top blue line) but could not strike
through it in a sound and sustained man-
ner, and the market traveled back down
and closed the gap. This simple approach
can be a powerful technique. It works in
any market on any time frame. To prove
that, let’s look at indexes, individual
stocks and commodities, on three time
frames.

Figure 4-5
In the previous figure, the stock did not
definitively penetrate the breakout level.
When prices do successfully break above
the line, as in Figure 4-5, how can you es-
timate where they will move to? Use my
Fibonacci price gap measuring formula
to find some possible price objectives.
Figure 4-6
Here’s how to do it: Just measure the
distance between the low of the bar
preceding the gap and the high of the
bar following the gap and multiply it by
the standard Fibonacci multiples used to
identify impulse waves with the Wave
Principle (1.618, 2.618, and 4.236).
If prices decisively penetrate the gap
breakout level, then we have three pos-
sibilities for where prices will end up.
Incidentally, you can use a momentum
study, moving averages, or MACD in
this type of market to assist with this
analysis.

Figure 4-7
Here’s the strategy at work, using a
monthly price chart for Cotton. Note
the breakout level marked by the top
short dark blue line. Next, measure the
distance from the high of the bar prior
to the gap to the low of the following
bar to the downside. Interestingly, prices
go down to the 2.618 multiple of that
measurement at 3403, toy with the area,
and then reverse. This kind of discov-
ery is what makes me passionate about
technical analysis even after 15 years of
looking at price charts. By using just two
price bars with a simple application of
basic Fibonacci math, we were able to
identify where this sell-off might cease
on a monthly scale and establish a strong
support level in the market.
Figure 4-8
Here is another example of Fibonacci
gap measuring analysis on a Lean Hogs
chart. I like to utilize the equalized active
charts for the meat complex. Measure
the high and low of the middle price gap
and project downward. A 4.236 multiple
comes in at 7040.

Figure 4-9
Measuring the lower price gap gives us
a 1.618 multiple coming in at 6713. The
Fibonacci gap measurement of both of
the gaps targeted a narrow range (be-
tween the dark blue lines) for a reversal
in Lean Hogs.
Figure 4-10
Here’s a weekly chart of Intel (Nasdaq:
INTC). By taking the range of the bar
prior to the gap denoted by the second
green arrow and adding it to the top of
the bar following the gap, we arrive at a
gap breakout level of 2129.

Figure 4-11
Since Intel’s price decisively penetrated
the breakout level, we next project for-
ward by measuring the distance between
the low of the bar preceding the gap and
the high of the bar after the gap. It broke
through the 1.618 multiple to attain
2.618, which sparked a short reversal
before traveling even higher to the 4.236
level. Again, a simple Fibonacci multiple
of two price bars identified 2798 as the
objective for the move spawned by this
price gap. The exciting part is that 2798
is the 4.236 multiple of this range —
only one penny off the high of 2799.
Keep in mind that it is rare to have such
a perfect fit. Usually, prices cut short or
exceed by a bit the projected Fibonacci
objective.
Figure 4-12
Price gaps do not have to accomplish
major jumps in price to be significant.
Take a look at the small gap in Gold on
the weekly price chart in Figure 4-12.
This chart portrays a common saying: A
picture is worth a thousand words. If you
look closely enough, this chart will tell
you a grand story. After prices decisively
penetrated the breakout level, the market
came within pennies of achieving the
2.618 multiple of the simple price gap,
backed off and then took off through its
6.854 multiple (the next highest Fibo-
nacci multiple above 4.236). When the
market reached each of these levels, they
sparked reversals.

Figure 4-13
Time and time again, you will see that
these Fibonacci levels spark reversals in
the market. Figure 4-13 displays a clear
hard gap on Silver’s weekly price chart.
The decisive penetration of the break-
out level at 15.73 (short dark blue line)
tells you that the price gap is neither an
exhaustion gap nor a common gap and
that the move will continue.
Figure 4-14
Where’s the Silver market going to go?
After completing a Fibonacci gap analy-
sis of two price bars, you know that it’s
going to go to one of three levels. As you
can see in Figure 4-14, the market easily
surpasses the 1.618 multiple, decisively
penetrates the 2.618 multiple, travels
right to the 4.236 multiple at 20.87, and
subsequently tanks.

Figure 4-15
Now, let’s similarly analyze Wheat’s
price chart. Here’s the chart with four
hard gaps marked by the arrows.
Figure 4-16
Figure 4-16 takes a closer look at the
first gap on the chart. By determining
the breakout level, you know what this
market must move below decisively to
tell you whether prices will continue to
move in the direction of the trend. If so,
the price gap is a breakaway gap or an
acceleration gap. There is no decisive
break of the blue line that indicates the
breakout level. Prices pushed through
it but couldn’t even get a weekly close
below this level. Therefore, you know
that the gap is most likely an exhaustion
or common gap and that the move will
not continue.

Figure 4-17
Sometimes the process can be slightly
trickier. On this same Wheat chart, I
used the gap breakout level technique
to project the breakout level (line with
pencil icon) for the second price gap in
green. Yet, can you say with confidence
that the market decisively penetrates
the level? On a weekly closing basis,
it clearly closed above the level, but
there was absolutely no conviction or
follow-through in the following week,
as it was an inside bar. My advice in a
situation like this is to wait until the fol-
lowing week, when there might be clear
evidence of penetration, and then apply
Fibonacci price gap measurements to
identify where this move might go.
Figure 4-18
The market closes above the 2.618 mul-
tiple, yields an inside week, and then
turns down.

Figure 4-19
Let’s continue on with Wheat’s next hard
gap to the downside. As a reminder, to
determine the gap breakout level, take
the range of the bar preceding the gap
and add it to the low of the bar follow-
ing the price gap (indicated by the 1.000
level on the chart).
Figure 4-20
Notice that the breakout level presents
a few issues again. The range of the
week following penetration of the level
is much smaller than the range of the
previous week, and the open and close
are very near to one another, meaning
that the bulls and bears do not know what
to do. Furthermore, the second blue line
drawn on top of the first actually closes
a soft gap, which provided support for a
market reversal.

Figure 4-21
Here is Wheat’s final gap to the high.
Just for argument’s sake, let’s say that
we think the market is working a series
of wave 1s and 2s to the upside and that
Wheat will climb to $30.00 a bushel.
You can use the information you’ve
learned to determine the breakout level
and targets following the price gap. For
the market to continue higher, it must
break through the 13.51 level; if it fails,
you can expect a retracement or at least
a change in trend.
Figure 4-22
Here are a few more examples of ana-
lyzing charts with multiple price gaps.
Bank of America’s chart (NYSE: BAC)
displays the gap breakout level technique
of the first price gap that occurred in
February 2008. Prices decisively break
through the breakout level to confirm
that this trend is bearish or, at minimum,
that the move is going to continue.

Figure 4-23
Next, we use the Fibonacci gap measure-
ment to determine the 2.618 multiple,
which is where the market fell to and
reversed.
Figure 4-24
Luckily, another price gap occurred in
the beginning of this downtrend to give
us even more information. Because the
breakout level for this gap was confirmed
by penetrating the price bar, you could
probably have ruled out the 1.618 down-
side target of the previous gap (see Fig-
ure 4-23) in favor of the 2.618 downside
Fibonacci gap measurement.

Figure 4-25
Interestingly, the Fibonacci gap mea-
surement of the second price gap (1.618)
correlates with this projection as well.
The two gaps form a range of 36.50 to
34.50, so that you could actually target
both price moves.
These examples demonstrate that
although the school of traditional
technical analysis relegates only a few
paragraphs to price gaps, they actu-
ally hold a world of information if you
merely observe closely and apply what
you’re learning.
Figure 4-26
You can also apply the same Fibonacci
gap measurement technique to soft gaps.
Figure 4-26 is a monthly chart of the
Dow.

Figure 4-27
For the price gap marked by a red circle,
measure the distance from the high of the
prior bar to the low of the following bar
and extend the distance to the downside
to reach the 2.618 multiple — the memo-
rable low in the Dow in 2002/2003.
Thus, you can see how price gaps are
extremely significant: They serve as
psychological markers and include infor-
mation that many people either overlook
or simply don’t understand.

Chapter 5
Price Gap Trade Setups
In this final section, we will focus on how to use price gaps to find trade setups. I have devised two types of
price gap trade setups to look for, called the double tap and the retest. Over the years, I have also written
about them in my Trader’s Classroom column.
The Double Tap Trade Setup

Figure 5-1
The first price gap trade setup that I
named the double tap (probably from
watching too much of The Sopranos on
HBO) involves two tests of the range of
support and resistance defined by price
gaps. In Figure 5-1, you can see the red
lines that denote support and resistance
drawn off of the three price gaps. Notice
that Soybean prices travel into the range
between the two red lines (labeled test
one) and then return to the range again
later (labeled test two). Here’s what
makes this situation a trade setup: an
impulsive move often follows the sec-
ond test.
Figure 5-2
Take a look at another example on this
chart of Live Cattle. The support and
resistance test range is defined by the
first green price gap and the third red
price gap. Test number one occurs in
late April/early May, and test number
two follows a month-long rally out of
the range. Again, the second test leads
to wave 3 of 3, a big impulsive move to
the upside.

Chapter 5 — Price Gap Trade Setups
Figure 5-3
This Carnival Corp. (NYSE:CCL)
weekly chart explains why I include soft
gaps in my analysis — although the chart
spans almost two years, there are very
few hard price gaps. Nonetheless, even
this one price gap marked by the green
arrow acted as a magnet for the market;
the gap level was tested twice as prices
approached the blue line.
Figure 5-4
The double tap price gap trade setup
can also work in a market traveling in
the opposite direction. Notice that I put
my level (marked by the horizontal blue
line) at the close of the bar preceding the
gap in red. The price gaps act as magnets
for the market and provide support and
resistance for tests 1 and 2. The second
test leads to the third-wave move or
the wave 3 of 3 that moves hard to the
downside.

Figure 5-5
You can also combine the double price
gap trade setup with the Fibonacci gap
measurement to successfully project
price objectives. In Figure 5-5, U.S.
Bancorp (NYSE:USB) makes a small
hard gap (in green) and then returns to
the range for tests 1 and 2. As usual,
the second test sparks the move up in
prices. Next, apply the Fibonacci gap
measurement technique by measuring
the distance from the low of the bar
preceding the gap to the high of the bar
following the gap and multiplying it by
Fibonacci levels — 1.618, 2.618, and
4.236. Our second test leads to prices
traveling right up to a 4.236 multiple, a
move from $27 to $37. Now, that’s an
amazing amount of information to derive
from one price gap.
The Retest Trade Setup
Figure 5-6
The second trade setup that uses price
gaps I call the retest. It is simply an at-
tempt to close the price gap. Let’s see
how it works on this daily chart of Cat-
erpillar (NYSE:CAT). The first step is to
create a range off of the bar preceding the
bearish gap that we call the “Sell Zone.”
Then look for a move into this area, the
retest, which is followed by a nice move
to the downside.
To take the same measurement for the
first bullish price gap (in green), first
create a “Buy Zone” range off of the bar
that precedes the gap, then look for a
move into the zone followed by a move
to the upside.

Figure 5-7
Next, apply some of what you’ve pre-
viously learned to determine where
the market is going to go after the Sell
Zone.
Looking at Fibonacci gap measure-
ments, prices fell to a 2.618 multiple
and thereby registered a bottom. The gap
breakout level technique showed that the
move to the downside after the second
bearish price gap would not continue.
Once prices got above the range of the
previous gap (indicated by the 0.000
blue line), you had an inkling that the
market was going to continue higher.
Prices came back then moved into the
Buy Zone and quickly reversed to the
upside.
Figure 5-8
Let’s see how well the objectives did. A
Fibonacci gap measurement of the first
bullish price gap (in green) in Figure 5-8
gives you the 4.236 multiple as a target,
which was almost reached.

Figure 5-9
A price gap breakout measurement of
the last bullish price gap on the right
of Figure 5-9 provided a breakout level
(marked by the top dark blue line), and a
Fibonacci price gap measurement analy-
sis offered the 4.236 multiple (marked by
the lower dark blue line). Because the top
did not reach the range of these levels,
there was no confirmation that the trend
would continue.
Figure 5-10
The weekly chart of Coffee in Figure
5-10 displays another example of the
retest trade setup. Note the two Buy
Zones created by the ranges of the bars
preceding the price gaps.

Figure 5-11
Here’s how to determine if the market
is going to continue higher: Complete
a gap breakout measurement of the
second price gap in green. Notice that
prices could not decisively penetrate the
breakout level (marked by a blue line)
and traveled back down near to the range
of the bar preceding the gap — the Buy
Zone. After prices reverse, where is the
market going to go?
Figure 5-12
A Fibonacci gap measurement correctly
projected the 1.618 multiple as a target.
The market then returned to the down-
side and tested the soft gap that occurred
earlier (marked by the extended blue
line).

Figure 5-13
These examples have been in different
time frames — daily, weekly, monthly
— but all have been from the same time
period. How did this technique work 10
years ago? This price chart of Walt Dis-
ney (NYSE:DIS) from 1998 reveals that
it works equally well. In short, I try to
spend my time and yours on techniques
that work across the board.
The first two price gaps on the Disney

chart do not penetrate their breakout lev-
els, so you know that the moves will not
continue. The next price gap (in green)
decisively takes out the breakout level,
and the Fibonacci price gap measurement successfully identifies the 2.618 Fibonacci gap target. In the later
stages of the move, another small price gap (in green), provides a new breakout level that is unsuccessfully
tested, and the market reverses to the downside. Similarly, prices don’t decisively penetrate the breakout level
for the next bearish price gap (in red). In April of 1998, another price gap to the upside eventually pushes
through the breakout level and right up to the new Fibonacci gap target of 2.618.
Figure 5-14
Next, a gap breakout level measurement
of the price gap following penetration of
the 2.618 level projects a breakout level
at the 1.000 line.

Figure 5-15
Finally, a gap breakout measurement of
the next price gap creates a range for
the breakout level. Because the price
action does not decisively travel above
these breakout levels, you can expect the
subsequent market reversal. The prices
then move down to the level of the price
gap (in green) that previously occurred
around 3650, and bounce back up. That’s
a powerful display of how well this kind
of price gap analysis can work in your
everyday trading.
Summary
Perhaps you can tell how much I like to work with price gaps. They are easy to find and easy to work with
once you get the hang of it. What always amazes me is how much information price gaps pack into those two
small bars that act as psychological markers. Now that you have learned more about them, I hope you will find
it easier to work with price gaps to find useful trade setups for yourself.

Chapter 6
Questions and Answers
Q. There are very few price gaps in Soybeans combined sessions chart. Could I go ahead and trade the
combined sessions off of clear gaps on the day pit chart?
Kennedy: Let me use an example of daily Soybeans.
Figure 6-1
As I stated before, I think that all
price gaps are important. First, I
would identify levels on my Soy-
beans day pit price chart using a
thin, lightly colored line in order to
remind myself that these price gaps
provide a certain price level in the
market — 1378 and 1310.
Figure 6-2
Then I would include those levels on
a combined sessions chart (as in Fig-
ure 6-2). However, because I think
that the cluster of price gaps on the
left of this combined sessions chart
is more significant, I would identify
them in a bolder color, as I did in red
in this figure.
Now, you’re able to differentiate be-
tween the hard gaps in the pit and the
combined sessions, and ultimately
identify a nice shelf of support in
Soybeans (circled in black). Again,
I would identify the price gaps that
occur in the pit session in a subtle
manner, because pit session price
gaps are basically the result of elec-
tronic combined sessions trading.

Chapter 6 — Questions and Answers
Q. What type of gap is Google in?
Figure 6-3
Kennedy: Based on the structure
and the Elliott wave patterns, it
appears to be an acceleration gap.
The largest move is marked by the
long blue line, and after the gap the
market has a wave-three personality.
In addition, notice that there was an
island reversal (a price gap to the
downside followed by a bullish gap
to the upside) on the left of the chart.
The market has the signature of what
I have labeled wave 1, wave 2, and
wave 3, followed by a pullback for
wave 4. Now this is probably the
first time I’ve looked at Google in
about three months, so I don’t know
if this outlook makes sense in the
larger context.
Q. Could you discuss the weekly chart of the Dow Jones?
Figure 6-4
Kennedy: To do that, I have to show
you this chart with the soft gap filter
on it, because there are few hard
gaps present. Although I find the
highest degree of reliability in hard
gaps, you can still apply many of the
techniques that you have learned to
soft gaps.
The market never penetrated the
breakout level defined at the 1.000
level for the first soft gap to the
downside.

Figure 6-5
A gap breakout measurement of the
next soft gap to the upside gives us a
breakout level marked by the higher
dark blue line. In this case, it is hard
to determine whether the prices de-
cisively penetrate the level, as each
following week fails to confirm a
clear move up.
Figure 6-6
Hypothetically, if I had taken a posi-
tion at this point, I probably would
have put my critical level for further
rally or a stop on any kind of long
position at the low of the bar marked
by the pencil.

Figure 6-7
After using the same technique for
the next bullish price gap, you realize
that the market is unable to penetrate
the breakout level and subsequently
travels to the downside.
Figure 6-8
Let’s skip over to the more interest-
ing price gap (third red gap on the
chart) that gives us some break-
through information. Because the
1.000 breakout level is decisively
penetrated, we will complete a Fibo-
nacci gap measurement next.

Figure 6-9
The market comes close to the 1.618
Fibonacci level a couple of times, so
we should analyze the next price gap
to continue our projections.
Figure 6-10
Measuring the range of the bar pre-
ceding the gap gives us the breakout
level. Be cautious in your following
moves. While the range of the last
week was very impressive, don’t pay
it much attention; rather, focus on the
close of last week’s bar in relation to
the breakout level.

Figure 6-11
We are now stopped at a very criti-
cal point. If the market is going to
reverse, this is a great area for it to
happen. If not, and we do see a de-
cisive breakout of this level, then we
can determine some objectives for
further downside movement, such as
the 2.618 multiple in Figure 6-11.
Figure 6-12
A Fibonacci gap measurement of the
last price gap gives us a 2.618 mul-
tiple as well. Thus, we can identify
the range from 12,000 to 11,500 as
critical support for a possible price
reversal. If this doesn’t happen, my
money is on further decline to the
10790 level initially.

Q. Is there an element of time involved with the gaps? For instance, John Carter says that a gap on an
index will move to close within 10 days.
Kennedy: I would have to say that it depends on the type of gap. A breakaway or acceleration gap will
most likely stay open longer than 10 days, whereas an exhaustion gap will probably close within 10 days.
Now I don’t like to throw out a static number like 10 days or to say that an island reversal can take only
three days, because the “rule of thumb” tends to change shortly after you lock yourself into it. But if it’s
something that you see with a degree of reliability, then stick with it.
Q. What if the second test in the double tap trade setup is lower in a bullish gap?
Kennedy: Let me demonstrate this situation with a picture.

Figure 6-13
I’ve labeled the diagram in Figure
6-13 for you Elliott Wavers so that
you can see how price gaps, the
double tap trade setup, and the Wave
Principle work together. In the first
example (top image), the two parallel
lines define two hard price gaps, and
prices enter into the range once for
test one and then at a deeper level
for test two. In the second example
(lower image) prices enter the gap
area for test one, but stop at a shal-
lower point for test two.
Figure 6-14
How do you proceed from here?
Look for a daily close above the
levels marked by red lines; this will
signal the completion of your second
test and a trade worth considering.

EWI eBook
How to Trade the Highest-Probability Opportunities:

Price Gaps
By Jeffrey Kennedy, Chief Commodities Analyst, Elliott Wave International
© 2010 Elliott Wave International
Published by New Classics Library
For information, address the publisher:
New Classics Library

Post Office Box 1618
Gainesville, Georgia 30503 US
www.elliottwave.com
ISBN: 978-0-932750-95-2

1296 0907 Price Gaps

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HOW TO TRADE

How to Trade the Highest-Probability Opportunities:

By Jeffrey Kennedy, Elliott Wave International

Chapter 1 — Price Gaps Defined 2

Chapter 6 — Questions and Answers 38

How to Trade the Highest-Probability Opportunities: Price Gaps 1

Price Gaps Defined

A soft gap, illustrated on the right,

How to Trade the Highest-Probability Opportunities: Price Gaps 2

How to Trade the Highest-Probability Opportunities: Price Gaps 3

Figures 1-6 and 1-7

How to Trade the Highest-Probability Opportunities: Price Gaps 4

How to Trade the Highest-Probability Opportunities: Price Gaps 5

How to Trade the Highest-Probability Opportunities: Price Gaps 6

How to Trade the Highest-Probability Opportunities: Price Gaps 7

The Importance of Price Gaps

How to Trade the Highest-Probability Opportunities: Price Gaps 8

How to Trade the Highest-Probability Opportunities: Price Gaps 9

How to Trade the Highest-Probability Opportunities: Price Gaps 10

How to Trade the Highest-Probability Opportunities: Price Gaps 11

How to Trade the Highest-Probability Opportunities: Price Gaps 12

The second blue line is an example of

How to Trade the Highest-Probability Opportunities: Price Gaps 13

How to Trade the Highest-Probability Opportunities: Price Gaps 14

How to Trade the Highest-Probability Opportunities: Price Gaps 15

The Gap Breakout Level

How to Trade the Highest-Probability Opportunities: Price Gaps 16

How to Trade the Highest-Probability Opportunities: Price Gaps 17

How to Trade the Highest-Probability Opportunities: Price Gaps 18

How to Trade the Highest-Probability Opportunities: Price Gaps 19

How to Trade the Highest-Probability Opportunities: Price Gaps 20

How to Trade the Highest-Probability Opportunities: Price Gaps 21

How to Trade the Highest-Probability Opportunities: Price Gaps 22

How to Trade the Highest-Probability Opportunities: Price Gaps 23

How to Trade the Highest-Probability Opportunities: Price Gaps 24

How to Trade the Highest-Probability Opportunities: Price Gaps 25

How to Trade the Highest-Probability Opportunities: Price Gaps 26

How to Trade the Highest-Probability Opportunities: Price Gaps 27

How to Trade the Highest-Probability Opportunities: Price Gaps 28

How to Trade the Highest-Probability Opportunities: Price Gaps 29

Price Gap Trade Setups

The Double Tap Trade Setup

How to Trade the Highest-Probability Opportunities: Price Gaps 30

How to Trade the Highest-Probability Opportunities: Price Gaps 31

The Retest Trade Setup

How to Trade the Highest-Probability Opportunities: Price Gaps 32

How to Trade the Highest-Probability Opportunities: Price Gaps 33

How to Trade the Highest-Probability Opportunities: Price Gaps 34

How to Trade the Highest-Probability Opportunities: Price Gaps 35

The first two price gaps on the Disney

How to Trade the Highest-Probability Opportunities: Price Gaps 36

How to Trade the Highest-Probability Opportunities: Price Gaps 37

Questions and Answers

How to Trade the Highest-Probability Opportunities: Price Gaps 38

Q. What type of gap is Google in?

Q. Could you discuss the weekly chart of the Dow Jones?

How to Trade the Highest-Probability Opportunities: Price Gaps 39

How to Trade the Highest-Probability Opportunities: Price Gaps 40

How to Trade the Highest-Probability Opportunities: Price Gaps 41

How to Trade the Highest-Probability Opportunities: Price Gaps 42

How to Trade the Highest-Probability Opportunities: Price Gaps 43

Kennedy: Let me demonstrate this situation with a picture.