Gaps trading strategy is a great way to make some extra bucks. Almost daily, a bunch of financial instruments open with a gap up or down. While smaller penny gaps should be avoided, significant stock gaps is an excellent potential opportunity for day traders. If you are not aware fully of differences, then we would suggest you have a look at this article first!
In this article, we would cover three amazing gap trading strategy. After that, some tips to help you a bit extra in trading gaps, followed by a conclusion.
Why do prices gap up?
- Gaps most noticeable irregularity between demand and supply. The gap is up because of aggressiveness by buyers; I intend, there are more buying at the open than there is available supply at the previous day’s closing price. The gap is down because of the aggressiveness by the sellers; I intend, there are more sellers at the open than feeling demand at the previous day’s close. Therefore, gaps are practically constantly at price levels where there is a supply and demand imbalance at the open.
- Gaps also occur due to the overnight attitude of the participant or any important news.
- Quick money trying to skip necessary support and resistance level, i.e. If they are bullish, they gap-up price above the supply zone
The Gap fill
The gap-fill refers to the price retrace and close the level where the origin of the gap occurs. The closure rate (gap-fill) for up gaps increases if the prior day’s open to close price trend was also up. The closure rate (gap-fill) for down gaps increases if the prior day’s open to close move was downward.
After the gap price tries to fill the gap. Another occurrence with gaps is that once gaps are filled by price, the gap tends to reverse direction and continue its way in the direction of the gap (for example, in the chart BELOW of RELIANCE, back upwards).
Profitable Gap Trading Strategies
It is the safest gap trading strategy. It always doesn’t inspire all the traders but surely is in the bucket list of many. Filling plan waits for the gap to fill itself. For instance, if an asset gets closed at $45 and starts trading at $50, with a price gap of $5, then let it fill again.
Once the gap would be filled, the chances are the asset would start to rise again and this time with no looking back. The reason behind this is, the asset which can cause a gap would quickly grow, and that gap fill is the lowest point it would touch.
Although, by following this strategy, you might miss many golden opportunities to earn money.
Gaps trading is a risky and volatile method to profit. And, that’s why the options strategy works the most effectively here. Options trading allows a trader to profit, even if he feels that price would fall, using put options.
Call and Put are the two trading methods in options trading.
A Call option is the right to buy any asset at a predefined price on a preset date, no matter what the cost of the asset is, that day. Thus, if you feel that any stock is going to rise in the upcoming time, then take the call option. Also, the best thing about call options is if the price of the asset doesn’t rise, or say falls, then you can nullify the contract.
Similarly, the Put option is the right to sell any asset at a predefined price on a preset date, no matter what the cost of the asset is, that day. Thus, if you feel an asset would fall, then go for the put option. The stock’s price would fall (as per your prediction), but you will purchase the right to sell the asset at the put option price. And don’t worry; put option prices are very similar to the current prices of the asset.
Thus, if you buy a put option asset today and the stock falls on the next day, you have the right to sell it at yesterday’s price pattern.
It is the best and the most popular technique to trade gaps.
Spread Gap Trading Strategy
The last strategy on our list is the spread trading strategy. In forex, the spread is the difference between ask and bid price. In gap spread trading, you buy one asset and sell another, and the difference is your profit, and this profit is the spread.
This strategy works very well on the breakaway gap, where the price trend is most probably known. Make sure to double earn using this strategy, one, from the stock you’ll sell, and second, the one you’ll buy. Any mistake in any of the assets can decrease your profits.
It is an instant-profitable and protected strategy to play with gaps; however, the profits are very less. Thus, either you need to put some extra bucks, or you need to purchase the asset with additional leverage.
So, these were the three best techniques to trade gaps. And, adding them to your strategy list can make you earn profits, as the gaps are very volatile, and these techniques are either risk-free or very less risky. The combination of volatility and low risk can make you earn a slow but steady income.
But, being aware of these techniques is not enough. You can still fall for many traps. The traps are created by financial investors and influencers to earn money. Therefore, here are some tips for you.
You will find that weak gap-ups are always Gap up to resistance or gap down to support. This price action is typically produced to trap you into a probably weak market and a bad trade, catching stop-losses on the short side and usually panicking traders to do the reverse thing.
Near the edge of an uptrend, the exhaustion gap occurred. Though that upward gap quickly disappears, and prices direct lower. When prices close under that exhaustion gap, it is normally a stagnant giveaway that the exhaustion gap has presented its presence. An exhaustion gap occurs with notably high volume.
Gap Trading Tips (Not General)
- Do not start trading or go long, as soon as you see a gap. Wait and confirm the trend. You can observe the asset until 10:00 am and then start playing. You can analyze the first candle in a candlestick chart, to be extra sure. It is a good indicator.
- Use stock screeners to analyze and spotting the assets.
- In any case, if the favourable outcome is not achieved, exit the trade market before closing. A stock that did not perform today has no confident prediction.
- Be wary of more than 1% gaps, whether up or down. If you spot any stock of more than 1% gap, take favourable action.
- Before investing, look for the trading volume. Usually, avoid a low volume asset’s gap because of the risk factor.
Gap Trading Rules
Fortunately, there are various ways for traders to profit from price gaps in the market. Some strategies are more successful than others. For example, many traders will purchase an asset when technical or fundamental chart factors suggest a price gap will likely occur during the following trading day. Other traders might prefer instead to fade gaps (by trading in the opposite direction) after support/resistance levels have established a clear price high or price low for the session. As a result, it can be said that there is no single approach that can be used to trade price gaps in all market environments.
The Final Say
Gap trading strategy is not as complicated as people think. It is quite simple; it is all about making small earnings during a day. Moreover, you do not need much to profit from gap trading, just some basic knowledge, which you will get here. And, some gap trading strategy and tips to follow with discipline.
You can use any technique out of the above or can also come with a combination. The primary line is to go with the strategy that works best for you.
At last, practice makes a person perfect. Thus, to avoid losses, you can start trading in a virtual account, or at least do not begin with a large chunk. Instead, go small!