A gap in a security chart occurs when its price increases or falls from the previous day’s closing without trading. Gaps are prevalent when news changes market fundamentals during closed hours, like an earnings call.
What Does a Gap Tell You?
A news event or occurrence that floods the security with buyers or sellers produces gaps. The price opens considerably higher or lower than the previous day’s closing price. Depending on the gap, it might signal a new trend or a reversal.
Gapping happens when a security or asset price starts significantly above or below the previous day’s closing price without trading activity. Partial gapping happens when the opening price is within the previous day’s price range but higher or lower than the closing price. Full gapping occurs if the open is outside the previous day’s range. Gapping, especially a complete gap, indicates an overnight emotional shift.
Traders aim to earn by playing the gap in such situations.
The Difference Between Gap Types
Key distinctions exist between common, breakaway, runaway, and exhaustion gaps.
- Usually, no noteworthy event precedes this hiatus. Common gaps are filled faster than others, usually within a few days. These “area gaps” or “trading gaps” usually have regular trading volume.
- A breakaway gap occurs when prices break above a support or resistance point, such as during a trading range. Breakaway gaps occur when the price breaks out of a regular trading range. Breakaway gaps can also result from chart patterns like triangles, wedges, cups and handles, rounded bottoms and tops, or head and shoulders.
- Runaway gaps, visible on charts, result from trading activity skipping successive price points, often due to investor interest. Thus, there was no security trading between the runaway gap’s start and termination.
- Exhaustion gaps are technical signals that occur when stock prices fall (typically on a daily chart) following a solid climb over several weeks. This indicates a significant movement from purchasing to selling, generally indicating deteriorating stock demand. The indicator suggests an upward trend may be ending.
Each gap type affects traders. Reversal or breakaway gaps usually increase trade activity, but familiar and runaway gaps do not—news, earnings, analyst upgrades, and downgrades cause the most gaps.
More frequent gaps don’t necessarily need a reason. Common gaps fill, while the other two may indicate a trend reversal or continuance.
Example of Gap
Amazon.com Inc. (AMZN) shares spiked higher on October 27, 2017, after months of sideways consolidation. The stock’s surge and enormous volume growth suggest a breakout gap. Amazon’s stock rose from $985 to $2,050 by September 2018.
Limitations of Gaps
Despite the obvious gaps, there are restrictions. The biggest problem is one’s capacity to spot gaps. Misinterpreting a gap might cost one a chance to acquire or sell an investment, weighing on earnings and losses.
- The price chart of an asset or security typically has a gap between trading hours.
- Each gap—Common, Breakaway, Runaway, and Exhaustion—has its own signal to traders.
- Gaps are apparent, but their kind is more challenging to determine.