Gaps occur when a stock opens significantly higher or lower than the previous close. Understanding gap types and how to trade them can provide consistent opportunities for prepared traders.
What is a Gap?
Definition
Gap:
- Price opens different from close
- Creates empty space on chart
- Result of overnight news/sentiment
- No trading occurred at gap prices
Gap Measurement
Calculation:
- Gap Up: Open > Previous Close
- Gap Down: Open < Previous Close
- Gap Size: Open - Previous Close
Types of Gaps
Common Gap
Characteristics:
- Random occurrence
- No significant catalyst
- Often fills quickly
- Low volume
Trading:
- Fade toward fill
- Low probability of continuation
Breakaway Gap
Characteristics:
- Start of new trend
- High volume
- Through resistance/support
- Catalyst driven
Trading:
- Trade continuation
- Don't expect fill
- Strong signal
Runaway (Continuation) Gap
Characteristics:
- Middle of strong trend
- Confirms momentum
- High volume
- Often halfway point
Trading:
- Trade in trend direction
- Measure move potential
- May not fill for long time
Exhaustion Gap
Characteristics:
- End of trend
- Final push
- High volume
- Quickly reverses
Trading:
- Look for reversal signs
- Often fills quickly
- Caution with continuation
Gap Trading Strategies
Strategy 1: Gap and Go
Concept: Trade in direction of gap
Setup:
- Strong catalyst
- High volume
- Clear direction
- No immediate reversal
Entry:
- Buy above opening high (gap up)
- Sell below opening low (gap down)
Stop: Below gap high/above gap low
Strategy 2: Gap Fade
Concept: Trade against gap for fill
Setup:
- No strong catalyst
- Gap into resistance/support
- Signs of exhaustion
- Common gap pattern
Entry:
- Short gap up at resistance
- Buy gap down at support
Target: Previous close (gap fill)
Strategy 3: Gap Fill Continuation
Concept: Trade continuation after gap fills
Setup:
- Gap fills partially
- Trend resumes
- Support/resistance holds
Entry: After gap fills and reverses back
Strategy 4: Opening Range Breakout
Concept: Wait for direction after gap
Setup:
- Gap occurs
- Define opening range (first 15-30 min)
- Trade breakout of range
Entry: Break of opening high/low
Gap Fill Statistics
General Patterns
Common Gaps:
- Fill rate: 70-80%
- Usually within days
Breakaway Gaps:
- Fill rate: 30-40%
- May not fill for months
Partial Fills
Concept:
- Gaps don't always fill completely
- Partial fill common
- Watch support/resistance
Gap Analysis Process
Step 1: Identify Gap Type
Ask:
- What caused the gap?
- What's the volume?
- Where is it relative to trend?
Step 2: Context
Consider:
- Market conditions
- Sector performance
- Stock's trend
- Support/resistance levels
Step 3: Volume Analysis
Check:
- Gap volume vs average
- High volume = conviction
- Low volume = weak gap
Step 4: Plan Trade
Define:
- Entry level
- Stop loss
- Target
- Position size
Pre-Market Gap Analysis
Morning Routine
Steps:
- Identify pre-market gappers
- Research catalyst
- Check volume
- Plan approach
Gap Scanner Criteria
Filter:
- Gap size (% or $)
- Volume threshold
- Price range
- Sector
Watchlist Creation
Include:
- Top gap ups
- Top gap downs
- Notes on each
Risk Management for Gaps
Position Sizing
Adjust:
- Gaps are volatile
- Smaller positions
- Account for slippage
Stop Placement
Options:
- Below gap area
- Below opening low
- Percentage based
- ATR based
Realistic Expectations
Understand:
- Not all gaps work
- Quick profits typical
- Cut losses fast
Common Gap Patterns
Gap and Hold
Pattern:
- Gaps and holds level
- Bases then continues
- Strong signal
Gap and Fail
Pattern:
- Gaps but immediately reverses
- Fills quickly
- Trap pattern
Gap and Trap
Pattern:
- Gaps one direction
- Reverses violently opposite
- Traps gap traders
Gap Trading Tips
Do
Best Practices:
- Wait for confirmation
- Use volume as guide
- Know the catalyst
- Have plan before market open
Don't
Avoid:
- Chasing extended gaps
- Trading without catalyst research
- Ignoring volume
- Fighting strong gaps
Gap Trading Examples
Bullish Gap and Go
Scenario:
- Stock gaps up 5% on earnings
- Opens and holds above gap
- Buy above first 5-min high
- Stop below gap area
Bearish Gap Fade
Scenario:
- Stock gaps up 3% on no news
- Gaps into resistance
- Short below opening low
- Target gap fill
Breakaway Gap
Scenario:
- Stock breaks out on news
- Gaps above 52-week high
- Buy continuation
- Don't expect fill
Key Takeaways
- Four gap types have different implications
- Common gaps tend to fill
- Breakaway gaps signal new trends
- Volume confirms gap strength
- Gap and go trades trend direction
- Gap fades profit from fills
- Research catalyst before trading
- Risk management is crucial
What's Next?
Learn about pre-market and after-hours trading.
This article is for educational purposes only and does not constitute financial advice.
Risk warning. This is education only, not financial, investment, tax or legal advice, and not a recommendation to buy or sell anything. Trading forex, CFDs, stocks, commodities, futures, options and crypto is high-risk; with leverage you can lose more than you deposit, and most retail traders lose money. Before you trade or invest in any form, check the local laws where you are and the rules of your country of residence, and consider your own financial situation; if in doubt, ask a licensed adviser. Past and tested results, and all examples, are for illustration only and do not guarantee future results.