Gapping refers to the phenomenon when a stock or asset’s price opens either above or below the previous day’s close, with no trading activity in between. This creates a discontinuity or “gap” in the price chart, often driven by major news or events that occur when the market is closed, like an after-hours earnings call.
Gapping can also describe the spread in lending and borrowing rates among banks, with a dynamic gap representing the shifting relationship between assets and liabilities over time.
Key Takeaways
- A gap happens when a security’s opening price is significantly above or below its previous closing price, with no trade occurring in between.
- Common gaps are usually partial gaps with smaller volumes, while more significant breakaway, runaway, and exhaustion gaps tend to fully bridge outside the previous price range.
- Each type of gap provides insights and signals for traders, denoting varying market sentiments and predictive price movements.
- Common gaps, appearing regularly, generally offer limited analytical value contrary to significant gaps that present strategical trading insights.
The Types of Gaps Explained
Common Gaps
Definition: Common gaps occur frequently and are characterized by minor price differences between the prior close and the new open. These gaps are typically inconsequential for long-term traders but indicate everyday market variability.
Breakaway Gaps
Breakaway gaps emerge when prices surpass a significant resistance or support level amidst a tight trading range or specific chart pattern. This type hints at the commencement of a robust directional move and often intimidates persistent trends for weeks.
Runaway Gaps
Appearing in the middle of a potent trend, runaway gaps support the notion of ongoing market strength. Traders observe these gaps as an endorsement towards sustaining the prevailing trend momentum over the forthcoming weeks.
Exhaustion Gaps
Occurring near the tail end of a trend, exhaustion gaps signify late quake entrant actions. These gaps suggest the culminated effort from lingering market participants, frequently followed by a quick price flip, hinting that the former trend has burned out.
Gapping and Stop Loss Orders
Due to the nature of unexpected movement, stop-loss orders can be executed at prices far beyond the intended limits. For instance, a trader with a long position buying a stock at $50 might place a stop-loss order at $45, only to be affected by a sudden company profit warning, resulting in an opening price of $38, which shifts the stop-loss into a market order filled at the far lower price.
Strategic Approaches to Gapping
Savvy traders often integrate gapping insights into their strategies. Here are a few approaches:
Buying the Gap (Up)
Often termed as “gap and go,” this approach involves entering a position on the day of the gap, deploying a stop-loss below the low of the gap bar. Successful trades indicate that the price should surpass significant resistance levels amidst high-volume trades.
Selling the Gap (Down)
The reverse strategy to buying the gap, traders execute short positions as the price gaps down.
Fading the Gap
Contrarian traders may leverage this approach targeting regular gap fillings, contrary to market movement, instituted with cautious stop-loss opposite to the gap direction, aiming near the previous close for target earnings.
Gaps as an Investing Signal
Identifying types like breakaway or runaway gaps can signal entrenched trends ripe for longer-term trading investments. Investors capitalize on these gaps, propelling their financial positions forward until signs of an exhaustion gap or critically trailed stops advise for exits.
Example of Gapping in Action
Assets like Meta (Facebook) visibly experience multiple significant price gaps around earnings claims and momentous announcements. Illustrated data remains pivotal in showing the real-life significance of gapping, impacting investor strategies effortlessly.
Volumetric Confirmation
Confirming a gapping direction often triangulates with volume data where substantial order executions fortify the gap’s intonation gauging long-term speculative efforts timing with highs illustrating runaway potential and lows drawing near exhaustion vectors.
Can Gaps Predict Uptrends?
While nobody holds accurate prophetic insights into future movements, emergent up-gaps frequently follow favorable news. Earnings outstrips, unexpected developments gaining market attraction can nearly assuredly pushop tensions onto minimum sustainable bounds.
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Related Terms: stop-loss order, breakaway gap, runaway gap, exhaustion gap, volume, position sizing, earnings call, trend reversal
