In simple terms, traders identify gaps between opening and closing prices on a trading chart where there has been volatile action, and can use this to devise an appropriate trading strategy. They will then need to calculate potential entry and exit points for their trades. Traders often use event-based strategies when there is a market gap, as they can predict but not guarantee what will happen next. There are also different classifications of gaps, as they do not all represent the same price pattern or trend on a price chart.
These can be split into the following:. There are two levels of gapping within the stock market: partial and full. A full gap shows that the market was particularly volatile overnight and the market sentiment for this share has changed. The imbalance between supply and demand of a particular stock pushes its price outside of support and resistance levels overnight, which leads to gaps in a chart.
Sometimes, this gap is filled back to its original level. This can indicate that the price rally was misunderstood, too optimistic, or investors have had a more thorough look at the earnings report and spotted weaknesses. Gap up stocks are relatively easy to spot on a price chart. Gaps in the market are shown as blank spaces between candlesticks, and gap up stocks are followed by a green candlestick on the open. This shows that there is a rally in price, which can either signal a new trend or it may be an anomaly.
Gap down stocks follow the same structure as gap up stocks, in reverse. The blank gap in the market is followed by a red candlestick, which signals that there has been a negative decline in price outside support and resistance levels. Although the price starts off in an uptrend, this market gapping soon reverses the stock into a downtrend.
When thinking about identifying buying and selling opportunities, traders can use gap trading rules to devise a trading strategy. Remember that not every gap represents the same opportunity, but we can make predictions based on market activity to find possible low-risk and high-reward trades.
The platform is especially effective for gap trading, as our clients are able to choose from a wide range of chart types, drawing tools and price projection tools in order to display data as clearly as possible. This way, you can study the price action of each individual stock to spot any gaps within its trend.
The most effective gap stocks to trade in the share market are those that are more volatile, and thus have more price fluctuations. Therefore, you should consider the sector that you would like to trade in. For example, oil and gas, pharmaceutical and retail stocks are considered particularly volatile sectors to trade, especially in the face of adverse economic conditions or a national recession.
Open a live account to get started or browse our range of platform tutorials. See why serious traders choose CMC. Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.
Personal Institutional Group Pro. United Kingdom. Start trading. What is ethereum? What are the risks? Cryptocurrency trading examples What are cryptocurrencies? The advance of cryptos. How do I fund my account? How do I place a trade? Here are the rules:. These large candles often occur because of the release of a report causing sharp price movements with little to no liquidity. In the forex market, the only visible gaps on a chart happen when the market opens after the weekend.
Let's look at an example of this system in action:. This does not look like a regular gap, but the lack of liquidity between the prices makes it so. Notice how these levels act as strong levels of support and resistance. We can see in Figure 1 that the price gapped up above some consolidation resistance, retraced and filled the gap, and finally, resumed its way up before heading back down. We can see there is little support below the gap, until the prior support where we buy.
A trader could also short the currency on the way down to this point and try to identify a top. Gaps are risky—due to low liquidity and high volatility—but if properly traded, they offer opportunities for quick profits. Those who study the underlying factors behind a gap and correctly identify its type can often trade with a high probability of success. However, there is always a chance the trade will go bad. You can avoid this first, by watching the real-time electronic communication network ECN and volume.
This will give you an idea of where different open trades stand. If you see high-volume resistance preventing a gap from being filled, then double-check the premise of your trade and consider not trading it if you are not completely certain it is correct. Second, be sure the rally is over. Irrational exuberance is not necessarily immediately corrected by the market. Sometimes stocks can rise for years at extremely high valuations and trade high on rumors, without a correction.
Be sure to wait for declining and negative volume before taking a position. Last, always be sure to use a stop-loss when trading. Technical Analysis Basic Education. Technical Analysis. Trading Strategies. Your Money. Personal Finance. Your Practice. Popular Courses. Table of Contents Expand. Table of Contents. Gap Basics.
To Fill or Not to Fill. How to Play the Gaps. Gap Trading Example. The Bottom Line. Trading Strategies Beginners. Part of. Guide to Technical Analysis. Part Of. Key Technical Analysis Concepts. Getting Started with Technical Analysis. Essential Technical Analysis Strategies.
Technical Analysis Patterns. Technical Analysis Indicators. Key Takeaways Gaps are spaces on a chart that emerge when the price of the financial instrument significantly changes with little or no trading in-between. Gaps occur unexpectedly as the perceived value of the investment changes, due to underlying fundamental or technical factors.
Gaps are classified as breakaway, exhaustion, common, or continuation, based on when they occur in a price pattern and what they signal. Article Sources. Investopedia requires writers to use primary sources to support their work.
The obvious type of gap is well, an actual gap in price. You will typically see this when the market opens on Sunday, after there has been some big news over the weekend. This was what the price action looked like when the situation in Greece was still up in the air. As you can see the gaps were fairly significant.
If you were in a long trade over the weekend, you could have lost money when the markets opened on Sunday. We see gaps when surprise news comes out, or if there is a lot of economic activity over the weekend. Traders want to capitalize on the events and suddenly move the market in one direction. These are some of the ways that you can choose to trade a gap. There are other ways to do it, but these are the most commonly taught methods. The most common way to trade a gap is to assume that it will get filled at some point.
In other words, you would enter the trade when the gap appears and target some point inside the gap. Some traders target half the gap, just to be safe, while others target the whole gap. The method you choose will depend on the pair you are trading and what your testing has told you works the best. Where to set the stop loss isn't as clear and will take some testing and experimentation.
So if your target is pips away from your entry, you would set your stop loss at 50 pips. A gap tends to get filled because the market wants to bring price back into balance after such a large imbalance. When the gap doesn't get filled right away, or it doesn't get filled completely, you could have a major followthrough on your hands.
Another way to trade a gap is to trade the price action after the gap is filled. Some traders assume that it will act as an area of support or resistance and that price will continue to move in the direction of the gap. So you would wait for the gap to be filled, before entering the trade. In this example, it worked out well and price rocketed back up, after the gap was filled.
To trade this method, you would have to judge the strength of the trend and make a call on a continuation. Instead of a physical gap, price simply moves very quickly through a price range. This is a concept that I learned from Chris Lori. Since there is actually price action through this price range, I consider it a Pseudo Gap. Whenever price returns to this area on the chart, it can have the tendency to run through that price range very quickly.
As you can see here, after the real gap was filled, price continued upwards to form a Pseudo Gap shown by the arrow. Then when price returned downwards, that area on the chart was filled quickly. So just like a Real Gap, this gap also has the tendency to get filled.
Since the price action associated with this type of gap is less sudden, the fill should also have less force. During this time, the ask and bid prices may change and this change is reflected in the opening price on the following day. In general, all markets with set market hours are often a subject to gaps in prices between trading and non-trading hours.
Although the Forex market operates 24 hours per day, the markets are technically closed during the weekends on Saturdays and Sundays. However, the forex market is only closed to retail traders. The large banks and hedge funds may still trade during the weekend and this trading creates gaps. Gaps tend to develop based on fundamental news during the period when the markets are closed to retail traders but may also be based on technical factors such as breakouts.
Therefore, although there are usually no gaps in the Forex market during the weekdays, gaps are common during the weekends. When trading begins on Sunday or Monday, the price can tend to move upwards in order to fill that gap. You can clearly see such situation in the chart below.
And if the gap was an upside gap, the price would tend to move downwards to fill that gap. The first type of gap is called a Breakaway gap. With a breakaway gap, it can indicate that a new trend is about to develop. Whenever the market is bound by ranges and the gap forms outside of this range, that is what is called a breakaway gap. Another type of trading gap is the Runaway gap in which the gap forms in conformance with the current trend.
For example, if the current trend is bullish and the gap that is formed is a gap up, then that gap is a runaway gap. Vice versa applies for bearish runaway gaps. The final type of trading gap is known as an Exhaustion gap. As the name suggests, this type of gap indicates a trend reversal following a long and prominent trend. The best way to trade the exhaustion gap is usually to watch the following candle and upcoming candlestick pattern or price action.
In the chart below, you can see that the following candle after the exhaustion gap formed the Doji candlestick pattern. This was a clear reversal pattern. Trading the gaps is a matter of choice. While some traders swear by trading gaps, other traders avoid doing so. Some traders have found that, depending on the particular currency pair, the gap tends to be filled in the majority of cases.
These traders therefore feel comfortable trading the gap.
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