Have you ever noticed a stock’s price opening higher or lower than it did the day before? This change, known as a ‘gap,’. Also, it isn’t just a coincidence. It can be a helpful hint for traders. For an instance, if you notice that the stock’s price is high in the opening session, it might mean there’s good news. On the other hand, a drop in stock price could mean something negative. This is what we call gap trading.
Identifying these gaps can give you a valuable edge. So, next time you see a gap on a price chart, remember it’s a clue about what’s driving the stock market.
Let us show you the various characteristics of market gap up or gap trading and how you can trade gaps!
What is Gap?
A gap refers to a situation where there is a huge difference between the closing price of the stock in one period and the opening price of the stock in the next period. Gaps can happen for several reasons. For example, a company might release its earnings report, or there could be new regulatory actions affecting the company.
However, it is not always negative.
Gap Trading is a strategy used in the stock market that means trading based on gaps in stock prices.
Types of Gaps in Trading
There are four main types of gaps: common, breakaway, continuation, and exhaustion.
Let us understand each!
Common Gap
A common gap is the most frequently experienced type. It tends to occur within the trading range of the previous day.
Let us say that a company’s stock closes at ₹100 on Monday and opens at ₹102 on Tuesday, without any trading activity in between.
This is a common gap.
Breakaway Gap
Breakaway gaps are significant price gaps that mark the start of a new trend. For instance, a stock closes at ₹80 on Tuesday and opens at ₹90 on Wednesday, making a noticeable gap-up. This could indicate a breakaway gap.
Exhaustion Gap
Exhaustion gaps occur near the end of a trend. It signals that the prevailing market sentiment may be losing steam.
For example, a stock has been on a steady uptrend, reaching ₹120 on Monday. On Tuesday, it opens at ₹124, creating a gap-up.
However, the stock fails to maintain the upward momentum and starts declining. This could be an exhaustion gap, suggesting the uptrend might be losing its strength.
Runaway Gap (Measuring Gap)
Runaway gaps, also known as measuring gaps, occur within a strongly trending market and are often observed about halfway through the trend’s progress.
Let’s say a stock is steadily rising from ₹80 to ₹100. Suddenly, it gaps up to ₹110.
These gaps act as a measure of the trend’s strength.
Causes of Gaps: What Drives Gap Trading
What might cause a gap:?
Let us take a look!
1. Unexpected News
Major announcements, like a company past earnings expectations or a significant policy change from SEBI or Reserve Bank of India, can cause gaps.
These events lead to sharp price moves as the market reacts quickly.
2. Technical Breakthroughs
Gaps can also occur when a security’s price crosses a previous high or low.
These gaps often happen because the price movement occurs outside regular trading hours.
The result?
This leads to noticeable jumps when the market reopens.
Such shifts can have a big impact on gap trading strategies.
- Gap Up Example
Let us say that XYZ Corp. closes at ₹100 on Monday. Overnight, news about a new product launch releases.
On Tuesday, the stock opens at ₹110. This creates a gap up.
2. Gap Down Example
Let’s talk about ABC Ltd., which closes at ₹200 on Wednesday. After hours, the company releases it quartely reports which is somehow negative.
On Thursday, the stock opens at ₹180, creating a gap down.
Gap Trading Strategy
Gap trading involves the idea of taking advantage of the times when a stock’s opening price is notably different from its closing price the previous day.
Willing to know more about market gap up or gap down?
A gap up occurs when a stock opens at a higher price than its previous close. On the other hand, a gap down happens when the stock opens lower than its last close.
Know the difference between gap up and gap down strategy!
Market Gap Up or Gap Down: Filling Gaps
Filling gaps refers to the price movement that returns to the level before the gap occurred.
While not all gaps are filled, some are more likely to be corrected than others.
To Fill or Not to Fill
When people say a gap is “filled,” it means the price has returned to the level it was at before the gap.
Technical Analysis Strategies
Gaps are also a key element in technical analysis. They can provide important clues about market trends. You an use them along with other indicators like moving averages, support and resistance levels, and volume analysis.
How to Trade Gaps in the Stock Market
Wondering how to trade gap up and gap down?
Here are some easy ways to help you understand the process of gap trading strategy.
The market opening gap strategy focuses on trading gaps that occur when the market opens.
1. Before the market opens, you must examine the potential gap opportunities based on the previous day’s price action.
2. Identify the price levels at which you want to enter and exit the trade. Using stop-loss and take-profit orders can help manage risk and lock in profits.
3. Keep a close eye on the market when it opens. If a gap occurs, you must observe how the price behaves and if it provides a trading opportunity as per your analysis.
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4. You must stick to your trading plan and avoid impulsive decisions. Market openings can be volatile, so maintaining discipline is crucial.
Volume Considerations in Gaps
When you’re looking at gaps in the market, you should never ignore the volume. If you see a gap up or down with high trading volume, it usually means there’s solid market sentiment. For instance, breakaway gaps, which signal the start of a new trend, often come with high volume.
On the other hand, if you notice an exhaustion gap with low volume, it could be a sign that the current trend is losing steam.
Conclusion
Gap trading offers opportunities for traders, but it comes with risks. Understanding gap types, strategies, and market sentiment is important. You must remember that patience and risk management are key to success.
FAQs| Gap Trading Strategy
You can benefit from gaps by trading in the direction of the gap and confirming it with technical analysis.
Investing in gaps can be risky, and thus, you should do proper analysis and risk management before making any final decision.
A gap in trading happens when a stock opens at a price that’s noticeably higher or lower than its previous closing price.
Gap trading can definitely be profitable, but it’s not a guaranteed win. Success in gap trading depends on how well you analyze the gaps and the strategy you use.
A gap up occurs when a stock opens at a higher price than it closed at the previous day. On the flip side, a gap down happens when it opens at a lower price than its last close.
There are four main types of gaps in trading: common gaps, breakaway gaps, continuation gaps, and exhaustion gaps.
Source: Investopedia
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Disclaimer: Investments in the securities market are subject to market risks; read all the related documents carefully before investing.