You must have seen empty spaces in a Candlestick or bar chart and wondered what happened there. It means that no trading of securities happened in this area which happens when price opens either higher/lower than previous day’s closing price. Gaps happen due to extraordinary buying or selling interest after the market(AMO) has closed most often due to some news or earnings report. It is quite normal and happens all the time. Look at this GOOG chart.
This here is a down gap happened on 24 Feb , monday due to CoronaVirus initial panic. If you observe carefully you can see multiple gaps both up and down gaps in the chart. Life of a trader is entwined with these gaps and everyone who trades or invests should have a complete understanding of gaps.
After having this knowledge we are better equipped in taking both trading and investing decisions. Lets dive in.
So there are mainly four types of Gaps:
Common gap is the most occuring gap and generally occurs due to no apparent reason or may be some stock specific news ( rights issue, ex-dividend. This tends to be filled very quickly usually within a few days to a few weeks. We must keep eye on the closing of the gap.
Trading gaps, as they are often called, accompany average trading volume signalling no confirmation of continuation of move and gets filled.
A breakaway gap occurs when the prices gaps up/down a resistance or a support zone and gets out of a consolidation range. When the price gaps out of an established trading range it tends to gather volume interest from traders. Don’t think that these gaps will get filled so easily or early. These gaps often form resulting from breakouts from classical price action patterns like wedges, triangles, head and shoulders etc.
See in the above chart , price traded in the range from june to october and finally broke out with heavy volume. These gaps signals the change in trend and we should find trade opportunities in this direction. Here in this chart, price never revisited 200 price range.
Runway gaps occur due to increased interest in stock mainly due to some news and invoking new investor interest. These gaps can happen within a trend also as traders may find this information quite positive for the stock.
See in the above chart of reliance industries, Mukesh Ambani announced the facebook buying stake in the telecom arm of Reliance Industries(JIO) enhancing both capability and reducing debt- a win-win. So price gapped up accompanied with heavy volume as traders grabbed whatever shares they could get.
These gaps happen near the end of a downtrend or an uptrend. These are the first signs of reversal in the market. These occur when there is a euphoria or panic in the markets. After a huge bull market, price gaps up only to witness profit taking which ultimately leads to gap fill.
Clearly there is a volume interest from speculators in the stock inn the late cycle of bull run but is immediately followed by a big red drop. Within a few days the gap got filled and the stock started a nice down move. The exhaustion gaps are easiest to spot.
Whether you are a trader or an investor, having knowledge of gaps certainly gives you a little bit more understanding of the mystical stock market. And yeah always remember Ride The Trend.