Gaps Trading – Know Everything and Make Profits: Gap trading is an easy and excellent approach to earn money. The traders can exploit these gaps and take full benefit out of it. But it is challenging to spot a Gap. Moreover, in most of the cases, one would only know the gap, once it shows up on the chart.
You might be wondering now, what is a “gap” in the trading world? So, this is my mistake! I started wrong. Don’t Worry Now; We would be clearing all your doubts here.
We would first start with understanding gaps, why they occur, then would discuss gap fillings, how to trade gap filling, and at last, different types of Gaps, followed by a fantastic conclusion post.
Understand Gaps Trading
A gap in trading is a time when no trading activities happened, and still, the price of an asset moved significantly upward or downward. In other words, if a commodity closes at any particular price, and the next opening day, it does not open at that same price, then this difference is a gap.
These gaps occur when the market closes; for instance, the forex market remains closed on weekends. Share market is usually the most affected by these gaps because the stock market opens and closes daily.
On the price chart, there would be a gap anybody can see if any Gap happens. The gap’s size depends upon the difference between the closing and opening price.
Remember, a Gap can be in any direction; prices can go down and up both, depending on the situation & asset.
Why Gaps Trading Happen?
There are plenty of factors which can create a gap in prices. These can be fundamental or technical, or both. It usually happens if any news, event, or hype, positive or negative, is flowing into the market.
A gap is nothing, but the result of over-purchasing or overselling of any asset. If the news is in favour, then it may create a long line of buyers, while if it is against any asset, it might generate a flood of sellers.
Note: A gap is generally a good indicator of an upcoming trend. It is directly proportional to the direction of the Gap. The reason is simple; a Gap is not usual. When any significant activity occurs, then a Gap is created, and the process continues for a while.
Let’s take a short and sweet example now.
Suppose, a company UVW Ltd. is trading at $35/per share, and it is performing well. Now suddenly, the company posted new expansion plans in other countries, reported the highest quarter earnings, and the sales were touching sky. In this situation, at any closing and opening day, UVW Ltd. might encounter a gap in its share prices, without any trading activity in the market.
A similar situation happened with Amazon Inc. in the last quarter of 2017. Its stock price created a gap because of the increase in the inventory level and delivery volume. As a result, Amazon Inc. has been in an upward trend, since then.
A gap-filling means when the price difference, which created gaps in the chart, fills. Generally, a Gap is the outcome of some hype; and thus, it usually fills up soon. In other words, when the price reaches its first level of trading, then the gap is filled.
However, there can be different types of gaps filling. Some of them are:
Full Gap Up: It is a situation when the price of an asset creates a price gap and never gets filled.
Partial Gap Up A situation when the price of an asset created a gap, but soon after, the maximum gap fills, and the price reaches just a little above the original price. Some people also regard it as a situation when the price gap is above the previous closing price but below the last day’s highest price.
Full Gap Down: This happens when the price of any instrument creates a downward direction gap.
Partial Gap Down: When the downward gap is almost filled and closed just a little below the previous price. Also, if the Gap is above the last day’s lowest price, then it is also a partial gap down.
Gap Fill: It is a rare situation. When the cost of the stock creates a Gap and closes precisely to the previous opening price.
What To Do in Gap Fillings?
Now you know what trading gaps and different types of gap-filling are. But, to be very precise, what you should do in each of them? Below are our suggestions:
Gap Up: Usually, most people would think to go long in a full or partial Gap up. However, a successful trader would see the buying pressure. The risk of loss is shallow, but a trader wants to earn from these gaps too.
Thus, if the buying pressure persists for some time after the Gap, then go long. And, if the buying pressure doesn’t sustain, then go short.
Gap Down: Similarly, a gap down happens because of any bad news or influence. If the price gap is lower than the previous day’s lowest value, and the seller pressure is high, then go short and sell them. However, it might be the case that news was temporary, and the gap down will bounce back. Generally, this kind of back happens in a partial Gap down.
Now, let us move to understand different types of gaps.
Types of Trading Gaps
1. Breakaway Gap
A breakaway gap is the continuation of a price pattern. They either create an upward or downward trend. It breaks the support and resistance** levels and starts trending the asset. It trends as an average-performing asset.
Support Level: A price level below which an asset is not allowed to go down, on any particular day, that’s why ‘support’.
Resistance Level: A price level above which an asset doesn’t trade. It is the maximum upward trend limit.
2. Continuation Gap
A continuation of runaway gap is created in the same direction as before. If an asset was already trending bullish, then this gives a boost to that bull. Similarly, if the asset is already going down, then this gap creates further swift downfall.
This gap prevails if already spread bad or good, news or event confirms.
3. Exhaustion Gaps
This gap reverses the trend. If an asset was trending upwards and any bad news comes, then it results in a Gap down. This gap down changes the price chart and moves downward now. Vice versa, for downward trending assets.
It might also occur if an asset is overbought or oversold. A good trader makes full use of this opportunity.
4. Common Gaps
The above types of gaps were hard to fill gaps and are not so frequent. However, the common gap is the most frequent asset price gap and gets filled fast. These gaps do not indicate any trend or reversal and are just a difference in the price range.
Usually avoid trading common Gaps, as these are the most unpredictable ones. The reason is these gaps do not occur because of any influence.
So, these were the different types of gaps. Spotting a Gap is difficult, but generally, the assets which are in news and events create Gaps because of unstable demand and supply.
The Final Say
As we told you, we would clear all your doubts about the gaps method and trading. Now, you almost know everything about a trading gap.
However, this comes after experience; to a beginner trader, we would suggest avoiding Gaps. You can first start observing these gaps; you will gain a lot of knowledge.
But, if a Gap has happened and the buying pressure sustains, then do your homework. After proper analysis, you can go long here. Just be double sure because the gap is a result of rumors and corrections happening soon.
You can also use market crash prevention tools like ‘Stop Loss” to avoid losses. Here is the full list of tools which might help you during a market crash.