Last week, I wrote about gaps and how they had become the most important feature on the chart of the SPDR S&P 500 ETF (NYSE: SPY). I showed a chart with a resistance level associated with a gap.

In particular, I noted that there was an important resistance level on the chart associated with the low of the day before the downside gap that marked the acceleration of the September decline. A break above that would indicate to technical traders that the decline has ended since a rally is expected when a gap is filled.

Last week ended with a break of that resistance level.

The break came on consecutive gap days. Historically, this has been an indication of strength, and it’s reasonable to expect additional gains in the next month.

Time To Buy?

The chart below shows the profit factor for a strategy that buys SPY only after two consecutive upside gaps compared to a random entry into SPY. Exits are based solely on time and are measured in days as shown on the chart’s X-axis. The value of 5, for example, indicates the trade is closed five days after the signal.

Profit factor is the ratio of gross profits to gross losses for each signal. In general terms, the profit factor shows the profit per unit of risk. Values greater than 1 show the signal is profitable, on average, in the long run. Higher values are preferable to lower values.

For SPY, over the past 20 years, even a random entry has been profitable over time. That is shown with the blue bars. Orange bars show the results for buying after gaps.

The chart shows we should expect some bullish follow-through this week. That could be followed by a brief pullback and then additional gains in mid-November.

Overall, that test matches what we would expect to see based on the psychology of gaps. Gaps tend to show excitement or panic. Two upside gaps like we saw last week indicate traders are worried about missing out on a big move. Downside gaps show a desire to sell associated with panics. Whatever the cause, two gaps in a row is something to pay attention to.

A Check On My Indicators…

My indicators are increasingly bullish, which confirms what we’ve been watching with gaps in the SPY chart.

My Income Trader Volatility (ITV) indicator appears to have peaked and is turning down, a bullish indication. The break of the moving average could come as early as this week.

My Profit Amplifier Momentum (PAM) did give a “buy” signal last week as expected. Its trend appears to be accelerating, a bullish indicator for the broad market.

PAM is designed as a short-term indicator. It shows a rally is likely to continue this week.

Action To Take

For the short term, based on my indicators, I remain bullish and will consider a pullback to be a buying opportunity.

In the meantime, I’m still sticking to using my proven system that leads to thousands of dollars in reliable income every month…

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