Those travelling on London's underground are always reminded to mind the gap. Investors using technical analysis would be well served to follow the same advice.
A gap occurs when prices move dramatically from the prior day's closing price and open the following day at a level much different from where it closed. Gaps higher occur when the next day's opening price is well above the prior close and a gap lower occurs when the next day's opening price is below the prior day's close. Typically, gaps offer great predictive value. If the gap is not closed within a few days, the gap will become resistance (in the case of gaps lower) or support (for gaps higher) that will guide future price swings.
Looking at the US Oil Fund (USO), we see the occurrence of gaps that paint a bearish view. Over three consecutive days, USO gapped lower three times (lines A, B, and C). The gaps were followed by two additional down days that pulled the stock within the 50% retracement level (blue arrow).
Having seen the retracement level hold, bulls may be anxious to ride these shares higher. I believe that would be a mistake. With a series of quick gaps lower, there is great overhead resistance that should stall any rally. While I would expect the shares to bounce toward the most recent gap ($34.50) any rally should stall at those levels. Investors would be best served to sell into strength and look to profit from the coming decline. Ultimately, the stock should consolidate between $31.50 and $34.50. Those who can effectively trade this range will profit.