Last week, reader Craig pointed towards my previous observation that gapped upside openings will always be closed, which translates into a market pullback.
The odds of this happening are extremely high, although I have not read any study confirming that this is a 100% occurrence. Let’s take a look again at an enlarged portion of the Domestic Trend Tracking Index (TTI): 
As you can see, the lower arrow shows a gap that was formed during the first quarter of 07. While the markets retreated a few weeks later, the gap was never completely closed. This is in contrast with a more recent gap (upper arrow) which was closed during the sharp pull back 2 weeks ago.
I have seen thousands of charts where these types of break-away gaps have been closed, the timing, however, has always been uncertain. Sometimes it happens quickly, as in the case with the upper arrow, sometimes it may take months.
How can this be of value to you? Recent gaps allow you to look at market behavior in a different light. When a correction occurs, such as we’ve seen over the past few weeks, you can look at the TTI chart and hold off making any sell decisions until the gap has closed. In many cases, this will also coincide with our sell stop discipline. Many times, after a gap has been closed, the markets will resume their previous trend, which was to the upside.
If the original gap in the above chart gets closed, that will put us at a very critical juncture in that most likely the trend line (red) will be pierced to the downside. However, there again is the chance of a rebound. That is why I evaluate the breaking of the trend line to the downside for a few days to be sure the break holds before issuing an all-out Sell signal.
Again, you need to be humble and accept the fact that there is no investment method which will get you in and out of the market correctly 100% of the time. However, having a plan that attempts to keep you away from the devastating impact of another bear market (whenever it occurs) sure beats the buying, holding and hoping approach that has proven to be a portfolio killer.
Comments 2
Ulli,
Thank you for this latest technical interpretation. It seems that emotions will always get in the way when making investment decisions, and this is critical for me as well others who are sitting on some gains that need to be protected.
If you noticed the action in the homebuilders over the last week you could have easily been hammered by the action in that sector. Does your sector work focus on this industry,and if so is it telling you to stay away from it?
Ray
Ron,
No, I don’t focus specifically on homebuilders but we sold our real estate positions early on in the year. Just look at the momentum figures and trend lines, and they will tell the story.
Ulli…