Candlesticks - Chart Gaps

<<<<<<< HEAD

Introduction

Gaps in charts are empty spaces between one trading period and another. They usually form because some information (exceptional earning report, profit warnings, mergers etc…) has come to light. Basically the opening price of the 2nd period moves substantially away from the 1st period’s closing price in post and pre-trading. It’s often said that “gaps will always fill”, meaning the price will move to cover the gap sooner rather than later. This doesn’t always happen, or may take some time to happen. These fills are quite common and occur because of the following.
  • Exuberance:  The initial spike may have been overly optimistic or pessimistic, therefore inviting a correction.
  • Technical Resistance: When a price moves up or down sharply, it doesn't leave behind any support or resistance
  • Price Pattern: Price patterns are used to classify gaps, and can tell you if a gap will be filled or not. We explore these gap types below. Exhaustion gaps are typically the most likely to be filled because they signal the end of a price trend, while continuation and breakaway gaps are significantly less likely to be filled, since they are used to confirm the direction of the current trend.
Gap Types

There are 4 gap types as highlighted in the following chart. Chartists will look at trend, volume and location of the gap when forming their trading decisions. The bullet points below the charts highlight the important aspects of the period gaps.

Here are the key things you will want to remember when trading gaps: 
  • Once a stock has started to fill the gap, it will rarely stop, because there is often no immediate support or resistance.
  • Exhaustion gaps and continuation gaps predict the price moving in two different directions - be sure that you correctly classify the gap you are going to play.
  • Make sure to wait for the price to start to break before taking a position.
  • Be sure to watch the volume. High volume should be present in breakaway gaps, while low volume should occur in exhaustion gaps. 
The Island Reversal 

The above Gap types can be found in specific Gap Reversal Patterns.  One of the most well known gap formations is the Island Reversal.  This reversal pattern is formed by a gap followed by flat trading period, then confirmed by another gap in the opposite direction. This can be found in an up trend or down trend and can be seen in the below chart.

The Island Reversal Pattern

The above Island Reversal is formed after an up trend. An exhaustion gap appears, followed by a consolidation, then a breakaway gap down. The quality of the reversal signal and the strength of the subsequent reversal are more robust if it comes at the end of a long trend. Notice volume too. There’s large volume going into the exhaustion gap and large volume going into the breakaway gap.

Trading Gaps - A Day Traders Perspective

"Fading" occurs when gaps are filled within the same trading day. For example, a company reports good earning, and price gaps up on daily open (meaning it opened significantly higher than its previous close). As the day progresses, traders realise that some not so good news is hidden within the depths of the report, so they start selling. Eventually, the price hits yesterday's close, and the gap is filled. Many day traders use this strategy during earnings season or at other times when irrational exuberance is at a high.

More on Trading Gaps - Some Popular Systems

There are many ways to take advantage of these gaps, with a few more popular systems highlighted below:
  • Some traders will buy when technical's favour a gap on the next trading day. For example, they'll buy a stock after-hours when a positive earnings report is released, hoping for a gap up on the following trading day. 
  • Traders might also buy or sell into highly liquid or illiquid positions at the beginning of a price movement, hoping for a good fill and a continued trend. For example, they may buy a currency when it is gaping up very quickly on low liquidity and there is no significant resistance overhead. 
  • Some traders will fade gaps in the opposite direction once a high or low point has been determined. For example, if a stock gaps up on some speculative report, experienced traders may fade the gap by shorting the stock. 
  • Lastly, traders might buy when the price level reaches the prior support after the gap has been filled.
To Sum Up

Remember, gaps are risky (due to low liquidity and high volatility). 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 risk that a trade can go bad. Make sure you gain further confirmation through technical analysis prior to trading, i.e studying volume. 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 that it is correct.


=======

Introduction

Gaps in charts are empty spaces between one trading period and another. They usually form because some information (exceptional earning report, profit warnings, mergers etc…) has come to light. Basically the opening price of the 2nd period moves substantially away from the 1st period’s closing price in post and pre-trading. It’s often said that “gaps will always fill”, meaning the price will move to cover the gap sooner rather than later. This doesn’t always happen, or may take some time to happen. These fills are quite common and occur because of the following.
  • Exuberance:  The initial spike may have been overly optimistic or pessimistic, therefore inviting a correction.
  • Technical Resistance: When a price moves up or down sharply, it doesn't leave behind any support or resistance
  • Price Pattern: Price patterns are used to classify gaps, and can tell you if a gap will be filled or not. We explore these gap types below. Exhaustion gaps are typically the most likely to be filled because they signal the end of a price trend, while continuation and breakaway gaps are significantly less likely to be filled, since they are used to confirm the direction of the current trend.
Gap Types

There are 4 gap types as highlighted in the following chart. Chartists will look at trend, volume and location of the gap when forming their trading decisions. The bullet points below the charts highlight the important aspects of the period gaps.

Here are the key things you will want to remember when trading gaps: 
  • Once a stock has started to fill the gap, it will rarely stop, because there is often no immediate support or resistance.
  • Exhaustion gaps and continuation gaps predict the price moving in two different directions - be sure that you correctly classify the gap you are going to play.
  • Make sure to wait for the price to start to break before taking a position.
  • Be sure to watch the volume. High volume should be present in breakaway gaps, while low volume should occur in exhaustion gaps. 
The Island Reversal 

The above Gap types can be found in specific Gap Reversal Patterns.  One of the most well known gap formations is the Island Reversal.  This reversal pattern is formed by a gap followed by flat trading period, then confirmed by another gap in the opposite direction. This can be found in an up trend or down trend and can be seen in the below chart.

The Island Reversal Pattern

The above Island Reversal is formed after an up trend. An exhaustion gap appears, followed by a consolidation, then a breakaway gap down. The quality of the reversal signal and the strength of the subsequent reversal are more robust if it comes at the end of a long trend. Notice volume too. There’s large volume going into the exhaustion gap and large volume going into the breakaway gap.

Trading Gaps - A Day Traders Perspective

"Fading" occurs when gaps are filled within the same trading day. For example, a company reports good earning, and price gaps up on daily open (meaning it opened significantly higher than its previous close). As the day progresses, traders realise that some not so good news is hidden within the depths of the report, so they start selling. Eventually, the price hits yesterday's close, and the gap is filled. Many day traders use this strategy during earnings season or at other times when irrational exuberance is at a high.

More on Trading Gaps - Some Popular Systems

There are many ways to take advantage of these gaps, with a few more popular systems highlighted below:
  • Some traders will buy when technical's favour a gap on the next trading day. For example, they'll buy a stock after-hours when a positive earnings report is released, hoping for a gap up on the following trading day. 
  • Traders might also buy or sell into highly liquid or illiquid positions at the beginning of a price movement, hoping for a good fill and a continued trend. For example, they may buy a currency when it is gaping up very quickly on low liquidity and there is no significant resistance overhead. 
  • Some traders will fade gaps in the opposite direction once a high or low point has been determined. For example, if a stock gaps up on some speculative report, experienced traders may fade the gap by shorting the stock. 
  • Lastly, traders might buy when the price level reaches the prior support after the gap has been filled.
To Sum Up

Remember, gaps are risky (due to low liquidity and high volatility). 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 risk that a trade can go bad. Make sure you gain further confirmation through technical analysis prior to trading, i.e studying volume. 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 that it is correct.


>>>>>>> c0fd65f8ac5b5830dc3df1d307fcababd602b3a9
Comments