Gap Analysis in Trading

Gaps occur when a stock opens at a different price than the previous close, creating an empty space on the chart. Understanding gap types helps predict whether they'll fill or continue. [DEFINITION] Gap: A break in prices on a chart where no trading occurred—price jumps from one level to another, leaving a visible gap. ### Types of Gaps **Common Gap:** - Occurs in trading ranges - Usually fills (price returns to close the gap) - Low significance - Often due to low volume or overnight news **Breakaway Gap:** - Occurs at the start of a new trend - Breaks out of consolidation pattern - Usually doesn't fill (or takes long time) - High volume typically accompanies it **Runaway (Measuring) Gap:** - Occurs in the middle of a trend - Shows acceleration of momentum - Often doesn't fill until trend reverses - Can help project price targets **Exhaustion Gap:** - Occurs at the end of a trend - Final push before reversal - Usually fills quickly - Often followed by reversal [TIP] If you can identify gap type in real-time, you can trade accordingly. Breakaway gaps should be bought/shorted; exhaustion gaps suggest the opposite. ### Gap and Go Strategy **When to chase the gap:** - Significant news catalyst (earnings, FDA approval) - Very high volume - Gapping through key resistance/support - Strong pre-market action [EXAMPLE] Biotech announces FDA approval. Stock gaps up 50% on massive volume. This breakaway gap is likely to continue higher—waiting for a "fill" could mean missing the move. ### Gap Fill Strategy **When to fade the gap:** - No significant news - Low volume - Gap into resistance/support - Overextended move [KEY] Studies show about 70% of gaps eventually fill, but this includes common gaps. Breakaway and runaway gaps fill much less frequently. ### Trading Gaps **Gap up in uptrend:** Bullish continuation, often buy the dip **Gap down in uptrend:** Potential trend change, watch carefully **Gap up in downtrend:** Potential trend change, watch for follow-through **Gap down in downtrend:** Bearish continuation, often a sell signal [WARNING] Trading gaps requires quick decision-making and risk management. Gaps can expand significantly, and waiting for a fill that never comes can mean missing the entire move. ### Measuring Gap Targets **Runaway gap projection:** Measure distance from trend start to gap, then project same distance above gap. [EXAMPLE] Stock starts trend at $50, gaps at $70 (runaway gap). Distance to gap = $70 - $50 = $20 Target = $70 + $20 = $90 [EXERCISE] A stock was in a 3-month uptrend, gapped up 8% on record volume after a blowout earnings report, breaking through major resistance. What type of gap is this, and what's your strategy? |ANSWER| This is a breakaway gap—occurs on significant news, breaks resistance, high volume, after a trend. Strategy: Look to buy on any pullback toward the gap area (don't expect a full fill), set stop below the gap, and ride the new trend. [SCENARIO] Stock gaps down 5% at the open with no news, average volume, in the middle of a trading range. By mid-morning, it's recovered 2% of the gap. What type of gap is this likely to be, and what do you expect? This looks like a common gap—no catalyst, average volume, in a range. Common gaps typically fill. Expect the stock to continue recovering toward the previous close. Trading strategy: Buy the gap with a target at the prior close (full fill) and stop below the day's low.