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What Is a Stock Gap?

A stock gap is an area discontinuity in a security's chart where its price either rises or falls from the previous day’s close with no trading occurring in between. Gaps are common when news causes market fundamentals to change during hours when markets are typically closed, for instance, an earnings call after-hours.

Understanding a Stock Gap

Gaps typically occur when a piece of news or an event causes a flood of buyers or sellers into the security. It results in the price opening significantly higher or lower than the previous day’s closing price. Depending on the kind of gap, it could indicate either the start of a new trend or a reversal of a previous trend.

Gapping occurs when the price of a security or asset opens well above or below the previous day’s close with no trading activity in between. Partial gapping occurs when the opening price is higher or lower than the previous day’s close but within the previous day’s price range. Full gapping occurs when the opening is outside of the previous day’s range. Gapping, especially a full gap, shows a strong shift in sentiment that occurred overnight.

Some traders make it a strategy to profit from playing the gap when such a situation occurs.

There are limitations despite gaps being easy to spot. The glaring flaw is one's own ability to identify the different types of gaps that occur. If a gap is misinterpreted, it could be a disastrous mistake causing one to miss an opportunity to either buy or sell a security, which could weigh heavily on one's profits and losses.

Types of Stock Gaps

There are some fundamental differences between the different types of gaps: common gaps, breakaway gaps, runaway gaps, and exhaustion gaps.

• Common Gap: In general, there is no major event that precedes a common gap. Common gaps generally get filled relatively quickly (usually within a couple of days) when compared to other types of gaps. Common gaps are also known as "area gaps" or "trading gaps" and tend to be accompanied by normal average trading volume.
• Breakaway Gap: A breakaway gap occurs when the price gaps above a support or resistance area, like those established during a trading range. When the price breaks out of a well-established trading range via a gap, that is a breakaway gap. A breakaway gap could also occur out of another type of chart pattern, such as a triangle, wedge, cup and handle, rounded bottom or top, or head and shoulders pattern.
• Runaway Gap: A runaway gap, typically seen on charts, occurs when trading activity skips sequential price points, usually driven by intense investor interest. In other words, there was no trading, defined as an exchange of ownership in security, between the price point where the runaway gap began and where it ended.
• Exhaustion Gap: An exhaustion gap is a technical signal marked by a break lower in prices (usually on a daily chart) that occurs after a rapid rise in a stock's price over several weeks prior. This signal reflects a significant shift from buying to selling activity that usually coincides with falling demand for a stock. The implication of the signal is that an upward trend may be about to end soon.

Each type of gap has certain consequences for traders. For example, reversal or breakaway gaps are typically accompanied by a sharp rise in trading volume, while common and runaway gaps are not. Additionally, most gaps occur due to news, or an event such as earnings or an analyst's upgrade/downgrade.

Common gaps happen more regularly and do not always need a reason to occur. Also, common gaps tend to get filled, whereas other gaps may signal a reversal or continuation of a trend.

Examples of a Stock Gap

In the example below of eunic-brussels.eu Inc. (AMZN), a small stock gap occurred between Oct. 26, , and Oct. 27, , when the price jumped from $ to $ This was a reversal of a downward trend which saw the stock's price continue to climb.

In the next example, of Alphabet Inc. (GOOGL), a gap can be seen from Oct. 24, , to Oct. 25, , when the price fell from $ to $ after weeks of a general price increase. The gap drop did not result in a continued downward trend, instead, the price continued to increase to its pre-gap level, filling the gap.

The Bottom Line

Price movements of an asset indicate to traders when it might be a time to buy, sell, or ignore what is happening in the market. Gaps, such as stock gaps, are large jumps in a security's price during non-trading hours due to external factors, such as news. When evaluating the gap, traders and investors need to determine the cause before taking any action.

Gaps in the Forex market help traders identify price movement clues, entry and exit signals, and trend reversals. In simple terms, gap trading is a disciplined approach to buy and sell assets. You can benefit from volatile markets in asset prices or gaps and turn these gaps into trading opportunities. Let's take a deep dive into what gaps are and how you can make the most of gap trading:

What is gap and gap trading?

A gap refers to the difference between the currency pair opening price and the previous day’s closing price. Any sharp upward or downward movement in the currency pair price can be termed as a gap. In gap trading, the traders find currency pairs that open at a higher price or an extremely low price than its previous day’s closing price, monitor its movement, and make a trade. Gaps can be identified as candlesticks on the Forex chart pattern, and sharp price movements are notably visible with low liquidity in the trading volume. Here’s how you can identify gaps:

• Look for strong support and resistance levels in the market
• If there is a strong resistance level and the currency pair price moves beyond that level before coming back to its original position, it signals to sell the currency pair
• If there is a strong support level, and the currency pair price moves below this level before coming back to its original position, it signals to buy the currency pair and limit losses

Four main types of gaps you need to know

1. Breakaway gaps

Breakaway gaps identify the strongest support and resistance price levels. They generally mark a trend reversal while moving out of a current trend.

2. Common gaps

Common gaps refer to a non-linear drop or jump from one currency pair price to another. As the name suggests, these gaps are the most common gaps to witness.

3. Exhaustion gaps

Exhaustion gaps occur when a steep decline in a currency pair’s price happens after a rapid increase. This gap signals traders that there is now a fall in the demand for the currency pair.

4. Runaway gaps

Runaway gaps in the Forex market occur in the middle of an existing trend. It occurs in the trend’s direction and is a gap that exceeds 5% of the currency pair’s price.

Top four gap trading strategies for Forex traders

1. Full gap trading strategy

The full gapping trading strategy occurs whenever a currency pair opens at a price that is above and beyond the previous day’s closing price. Full gaps indicate a strong market sentiment shift and send entry and exit signals to the traders.

• Whenever prices open beyond the previous day’s high price, it sends a long position or buy signal
• When prices drop below the opening price in the first trading hour, it sends traders a sell or short position signal
• Any sharp decline in the prices when compared to the previous day’s closing price and a day before’s low price, signals traders to place a long position order
• When a currency pair opens below the previous day’s lowest price, it sends a signal to the traders to short the trade immediately

2. Partial gap trading strategy

The partial gapping trading strategy occurs whenever the currency pair’s opening price moves beyond or below the last day’s closing price. But the opening price remains within the last day’s pricing range. The partial gap trading strategy allows traders to place trailing stop orders of around 6%.

• Whenever the currency pair opens beyond the previous day’s closing price, but below the previous day’s high price, it sends traders a signal to buy more of the currency pair
• Whenever the price for the current day is lower than the previous day’s closing price, it sends traders a buy signal
• Whenever the currency pair opens at a price less than the previous day’s closing price, it signals traders to short the trade

3. End of day gap trading strategy

The end of day gap trading strategy involves the traders scanning and reviewing the currency pairs at the end of the trading day to analyse which ones have the best potential. Since the Forex market functions 24 hours a day, from Sunday to Friday, the end of the day for Forex traders is P.M. EST on Fridays. The volatility during this hour sends a strong indication to traders about the continued movement in the market along the gap’s direction.

• Whenever the currency pair price witnesses a gap that goes beyond the resistance level, it sends the traders an entry signal for the upcoming next week
• Whenever the prices witness a gap that moves below the support level, it sends the traders an exit signal in the market for the upcoming new trading week

4. Modified gap trading strategy

In a modified gap trading strategy, a trader places positions in the middle of a market trend. The only requirement to trade the modified gap trading strategy is that the currency pair must be trading twice (at least) the average trading volume since the last five trading days.

• Whenever a currency pair opens at the previous day’s highest price, it sends the traders a buy signal. The price for the long or sell order should be equal to the average of the high price and opening price for the current day’s first trading hour
• Whenever the price opens at less than the previous day’s lowest price, it sends a sell signal. The price for the long or sell order should be equal to the average of the low price and opening price for the current day’s first trading hour

Gap trading strategies to use in your trades

Trading the currency pair price’s gap enables you to identify potentially profitable positions. Blueberry Markets is a trading platform that delivers all the charts and informational material about different Forex trading strategies that you can apply to maximise your profits and minimise your losses. Sign up for a live trading account or try a risk-free demo account.

A gap is nothing but an empty space formed between two successive candles (or bars) representing a change in the exchange rate of a currency pair. Generally, when a candle gets completed according to the time frame used by a Forex trader, the next candle will open such that there will be an overlap of the closing price of the completed candle and the opening price of the new candle. However, in a gap formation, there will be a huge gap between the closing price of the completed candle and the opening price of the new candle. The new candle can form above or below the completed candle as shown in the figures below.

An example of a positive Forex gap:

An example of a negative Forex gap:

Why Does Gap Form?

A gap formation occurs when the sentiment turns extremely bullish or bearish towards a currency (or any other asset). Gaps can occur in any timeframe and can happen at any time. However, Forex markets being highly liquid, gaps are formed usually at the beginning of a new trading week.

When there is a sudden change in the sentiment, buyers or sellers would make a frantic attempt to enter or exit a position. That would create a price gap on the upside or the downside. If the sentiment has turned bullish all of a sudden, then Forex traders having a short position in a currency would try to outbid each other, thereby creating a huge price gap on the upside.

Likewise, if the sentiment has turned bearish suddenly, then Forex traders having a long position would compete to exit at the earliest, thereby creating a huge price gap on the downside. Unexpected economic or political news causes a change in the sentiment required to produce big currency rate gaps.

For example, back in April , when Theresa May, the Prime Minister of the United Kingdom, announced snap election, a majority of market participants anticipated a huge victory for the Conservatives. Surprisingly, Theresa May and her party lost the majority, and the election resulted in a hung parliament. That dampened the sentiment towards the Great Britain pound, thereby leading to a negative gap opening in the GBP pairs.

It is not uncommon to see the price reverse at some point in time and close a gap created previously. However, there is no guarantee that it would happen. Even in the case of a price reversal, there is no definite time frame for the gap to be filled. Depending on the strength of the underlying sentiment, a gap may be filled within a day, week, after several months, or never at all.

Depending on the nature of formation, gaps can be grouped into four categories.

Breakaway Gap

A breakaway gap can be seen at the beginning of a big price movement and at the end of a consolidation phase of a currency pair. Since such gaps are formed when a currency pair breaks out of a non-trending pattern to a trending pattern, it is referred to as a breakaway gap.

The GBP/USD pair formed a breakaway gap on June 8, , following the exit polls' prediction of hung parliament in the UK.

Runaway or Continuation Gap

It is formed around the middle of an uptrend or downtrend of a currency pair. Since the trend remains unchanged after the formation of the gap, it is one of the most reliable patterns to trade with. The image below shows a continuation gap formed by the EUR/USD pair on April 23,

Exhaustion Gap

An exhaustion gap is usually seen in the final leg of a downtrend or an uptrend. The pattern is confirmed on the basis of low volumes. The EUR/RUB chart below shows an exhaustion gap formed few days before the second round of the French election, conducted on May 8,

Common Gap

A common gap is formed when an overwhelmingly positive or negative news is announced. For example, retail sales, unemployment change, NFP, and GDP growth data can result in the formation of common gaps. When IHS Markit reported a lower than anticipated flash manufacturing PMI (US) on March 24, , the USD/CAD pair made a common gap pattern as shown in the chart screenshot below. Earlier that day, Statistics Canada had reported better than expected core CPI data.

It would be an interesting opportunity to create trading strategies once you become well experienced in identifying price gaps and their nature as they form on the chart.

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In volatile markets, traders can benefit from large jumps in asset prices if they can be turned into opportunities. Gaps are areas on a chart where the price of a stock (or another financial instrument) moves sharply up or down, with little or no trading in between. As a result, the asset’s chart shows a gap in the normal price pattern. The enterprising trader can interpret and exploit these gaps for profit.

This article will help you understand how and why gaps occur, and how you can use them to make profitable trades.

Gap Basics

Gaps occur because of underlying fundamental or technical factors. For example, if a company’s earnings are much higher than expected, then the company’s stock may gap up the next day. This means that the stock price opened higher than it closed the day before, thereby leaving a gap.

In the forex (FX) market, it is not uncommon for a report to generate so much buzz that it widens the bid-ask spread to a point where a significant gap can be seen. Similarly, a stock breaking a new high in the current session may open higher in the next session, thus gapping up for technical reasons.

Automated program trading (i.e., algorithmic trading) is a relatively new source of gap price action. The algorithm might signal a large buy order if, for example, a prior high is broken. The size of the algorithmic order may be such that it triggers a price gap, breaking above the recent high and drawing in other traders to the directional movement.

Gaps can be classified into four groups:

• Breakaway gapsoccur at the end of a price pattern and signal the beginning of a new trend.
• Exhaustion gapsoccur near the end of a price pattern and signal a final attempt to hit new highs or lows.
• Common gapscannot be placed in a price pattern—they simply represent an area where the price has gapped.
• Continuation gaps, also known as runaway gaps,occur in the middle of a price pattern and signal a rush of buyers or sellers who share a common belief in the underlying stock’s future direction.

To Fill or Not to Fill

When someone says a gap has been filled, this means that the price has moved back to the original pre-gap level. These fills are quite common and occur because of the following:

• Irrational 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. 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.

When gaps are filled within the same trading day on which they occur, this is referred to as fading. For example, let’s say a company announces great earnings per share for this quarter and it gaps up at the open (meaning it opened significantly higher than its previous close). Now let’s say, as the day progresses, people realize that the cash flow statement shows some weaknesses, 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.

How to Play the Gaps

There are many ways to take advantage of these gaps, with a few strategies more popular than others. Some traders will buy when fundamental or technical factors favor 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, if it hasn’t already happened in after-hours trading. 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 stock when it is gapping 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 (often through other forms of technical analysis). 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. An example of this strategy is outlined below.

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 you correctly classify the gap that you are going to play.
• Retail investors usually exhibit irrational exuberance; however, institutional investors and algorithmic systems may play along to help their portfolios, so be careful when using this indicator and 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. 

Gap Trading Example

The daily chart of Apple Inc. (AAPL) above shows many gaps, which is quite normal given the propensity for equities to gap above or below the previous day’s price action, when the market is closed but news is still forthcoming and filtering into the market price.

Let’s take a closer look at some of the gaps that occurred. Starting from the left, we can see a bullish engulfing line, suggesting the move lower may be reversing (candlestick analysis). This is followed by a bullish gap higher, further suggesting that a low is being formed. An attempt at the downside is made again, but another large bullish engulfing line signals a low may have been made.

In the center, we see a bearish exhaustion gap, indicating that the move higher is running out of steam and may be reversing. The gap is filled relatively quickly, but it continues to act as resistance (horizontal yellow arrow), suggesting that downside potential remains. Finally, on the right side, in the midst of a reversal higher, we see a strong runaway gap indicating further upside potential.

As you can see, gaps are important price developments, leaving some in the dust and others to quick profits. At the minimum, gaps are important features of a security’s price action and should be monitored closely for potential trading opportunities.

The Bottom Line

A gap occurs when the market price of a security jumps to another price level, either higher or lower, where little if any trading has taken place. A good example is an unforeseen comment from a senior Fed official regarding the direction of interest rates. Once the comment hits the newswires, markets may react immediately, with market makers pulling their bids and offers. This may cause a price gap from the last price at $ to $, for example.

Gaps are frequently seen in price charts of almost every security. In stocks, the most frequent and significant gap occurs between the daily close and open of the exchange. In FX markets, since they operate 24 hours a day, a gap may not be visible (possibly on a one-minute chart) but instead appears as a very long candlestick covering the gap in price. (FX markets may experience gaps over the weekend, between the Friday New York close and the Sunday Asia opening.)

Price gaps can bedevil traders, especially if they’re on the wrong side of the gap. The most attractive trading opportunity with gaps is to go long or short as the market moves to close, or fill, the gap. In the example above, a reasonable trade strategy would be to buy the security that has broken higher from $, in a zone between $ and $, in case it doesn’t completely fill the gap. Should the price eventually fall back below the breakout price of $, it may suggest that the gap higher was unsustainable and that the downside remains most in play.

When to close a position?

The Gap Close strategy uses two profit targets and a stop loss to protect the position. The first profit target corresponds to half the distance of the gap. The second profit target corresponds to the full distance of the gap. Traders tend to open positions which can be split into two, resulting in an equal position size for each profit target. Other split ratios than 50/50 are possible. These can be set, as usual, in the Designer dialog.

The stop loss is a fixed stop. This stop is in essence a safety net as it is placed relatively far from the entry price (default ticks).

What to do when the target(s) are not reached and the stop is not triggered? Manually close the position on Wednesday.

The example shows a short sell signal on the EUR/NZD. Half of the position is closed when the first target (half the gap, green line) is reached. The other half of the position is closed when the market closes the gap. The red line indicates the stop order.