Today we’re going to look at different types of gaps that can appear in the stock market including common gaps, outlier gaps, outlier gaps, and exhaustion gaps.
Technical analysis can be pretty intimidating if you’ve never used it before.
So what is it and how do you start using it?
Technical analysis uses price actions and chart patterns to analyze and predict future price movements.
The other type of analysis is known as fundamental analysis and uses the financial statements and audits of the company itself to predict future price movements.
Which one is better?
Neither are foolproof and it really depends on how you want to approach trading.
As for technical analysis, you are likely already doing technical analysis.
Have you ever looked at support or resistance levels?
How about indicators like MACD, RSI, CCI or moving averages?
Do you ever notice a Chart pattern like head and shoulders or triple tops?
These are all examples of technical analysis.
Today we’re going to focus on a group of chart patterns called the gap chart patterns.
We’re not going to put together a strategy using technical indicators and the chart patterns, but if you want to trade this chart pattern you should definitely include an indicator or two.
Gaps arise when a share or another trading instrument is opened above or below the closing price of the previous day.
Partial gaps occur when the opening price is higher or lower than the closing price of the previous day, but is within the price range of the previous day.
A full void occurs when the opening price is completely outside the range of the previous day.
Gaps, especially a full gap, indicate a large shift in market expectations.
Usually there is not a major event that precedes this type of void.
Frequent gaps usually fill in relatively quickly compared to other types of gaps, usually within a day or two.
Common gaps are also known as “territory gaps” or “trade gaps” and are usually associated with normal trading volume and are often shown as partial gaps.
The presence of common gaps gives us no real indication of where things are going, since common gaps are relatively small, regular events in the price movement of a security.
Technical analysts often name gaps filled gaps.
A filled void refers to when the price of a void declines to where the void occurred.
For example, if a stock closed at $ 40.00 on Friday and opened at $ 41.50 on Monday, the daily price on Monday will typically contain the price level of $ 40.00.
An outlier gap indicates a critical price movement outside of a range or other chart pattern.
An outlier gap occurs when the price gaps are above a support or resistance level, as we see when a stock is in a trading range.
When price breaks out of a well-established trading range across a gap, it is a breakaway gap.
A tear-off gap can also break out of other chart patterns such as triangles, wedges, double or triple tops or bottoms.
Breakaway gaps are useful for confirming a new trend.
For example, the previous trend could have been higher, the price may continue to hit the resistance level, and then it has a tear-off gap above the resistance.
This would tend to confirm that the stock is seeing another strong uptrend.
The breakaway gap tends to show strong conviction from the bulls and in this case confirms a possible breakout.
Best of Options Trading IQ
A breakaway gap with a high volume compared to the average trading volume indicates a strong belief in the direction of the gap.
A rise in volume due to an outlier gap confirms that the price is likely to continue in the direction of the breakout.
If the volume in a tear gap is low, there is a greater likelihood of failure.
A failed breakout occurs when the price is above the resistance or below the support but fails to sustain the price and returns to the previous trading range.
In the following table with AAPL, three gaps are marked.
The first comes when price forms a triangle pattern after a downtrend.
The price then fluctuates above the triangle when the volume is high and then continues to rise.
This is a abandonment gap associated with a profit notification.
During the uptrend that followed, the price also experienced some out of control gaps.
The first loophole that got out of hand was unrelated to the outcome.
The second outlier gap marked in the graph was associated with the result.
These gaps all occurred at high volume.
Outlier gaps usually occur during a strong trend and indicate that the trend is strong enough to indicate that the trend is strengthening.
These are usually large gaps with price movements that move in the direction of the trend over a longer period of time.
A runaway gap occurs when trading activity skips successive price points, which is usually due to strong investor interest.
It is usually defined as a gap of 5% or more that occurs in the direction of a current trend and is usually associated with above average trading volume.
Photo credit: Investopedia
The psychology behind a runway gap is that traders who didn’t get in during the initial move are tired of waiting for a retracement, joining what they perceive to be a trending market, and stepping in en masse.
This sudden buying or selling interest happens quickly, usually accompanied by an unexpected message forcing the market maker to place it Commandments / questions at price points further from the last traded price before a gap forms.
The willingness of traders to get involved, which sometimes verges on panic, leads them to trade at this broad price level, causing the price of the security to jump up or down, causing the runaway gap to form .
When a trend comes to an end, there can be a fatigue gap.
A fatigue gap occurs towards the end of a trend and is caused by one final group of buyers who regret not having bought before.
In a downtrend, a fatigue gap is a void created by sellers.
An exhaustion gap is similar to a runaway gap, except that an exhaustion gap is usually associated with a very high volume, as opposed to an above-average volume associated with an out of control gap.
Traders can expect exhaustion gaps to fill up quickly.
Since a fatigue gap usually occurs towards the end of the trend, any progress the gap makes is usually erased (gap filled) within a few weeks, and often within a few days.
The gap day shows that sellers have entered the market aggressively and seemed more concerned with getting out at any price than with maintaining a good price for the stock.
The day after that, the gap opens higher and closes deeper, leaving a large, red-colored candle that represents a tremendous amount of sales that day.
The second example circled in the graph does not occur immediately after the peak in prices, but it clearly violates the trend line and creates the conditions for significant price reductions afterwards.
Disclaimer: The information above applies to For educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are unfamiliar with exchange-traded options. All readers interested in this strategy should do their own research and seek advice from a licensed financial advisor.