Playing the Gap: Identifying and Trading Gaps
by Chart School - April 28th, 2010 9:49 pm
Playing the Gap: Identifying and Trading Gaps
Courtesy of Pharmboy
Gaps are very profitable technical indicators. A gap is an area on a chart where no trades take place and these are caused by fundamental or technical events that usually occur after the market closes and before the market opens, also known as ‘non-regular trading hours’ (NRTH’s). There are four basic gap types: area, continuation, breakaway and exhaustion.
Gaps are significant for many reasons:
- Gaps tell traders that something occurred during NRTH’s. Typical events include: earnings announcements, FDA approvals, analyst upgrades/downgrades, company press releases and other significant events that may cause investors and traders to place orders to buy or sell during NRTH’s, causing an order imbalance.
- The type of gap will help you determine the probability of the stock’s direction in the short and intermediate term.
- Gaps are profitable. Traders can take advantage of the imbalance of orders by either “catching the momentum” or “fading the gap”. When riding a gap, the traders are betting that the stock will continue in the direction it gapped. When a trader fades a gap, they are betting that the gap will “fill” and move opposite of the gap’s opening direction.
Types of Gaps
Area Gaps
Area gaps are usually small and unimportant. They are also referred to as “common gaps” because they occur so frequently. Characteristics of area gaps are that they are fill very quickly. When the word “fill” is used, traders are referring to the gap’s closure. The gaps usually occur in trading ranges and they form on very low volume. Because of the low buying volume of the stock, the gap cannot sustain itself, thus filling relatively quickly.
The easiest way to determine if a gap will fill is to watch the first 30 minutes of the day. If the candlesticks appear to be fading in the opposite direction, it’s very difficult to stop it. This is because many others see the same fade and will jump on board. Remember, a gap does not have to fill on the same day of the gap. These types of gaps are unpredictable and are hard to trade. Figure 59 an example of an area gap.
Figure 59. Area gap.
Continuation Gaps
Continuation gaps are extremely important because they “continue” a trend. They are also known as “runaway” or “measuring” gaps and they do not fill quickly. These…
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Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
Ilene is editor and affiliate program
coordinator for PSW.