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.
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:
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 More on Trading Gaps - Some Popular Systems
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. |
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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.
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:
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 More on Trading Gaps - Some Popular Systems
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. |
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