The runaway gap is crucial to understand if your strategy revolves around trend following. This type of gap can signal a continuation of a price trend that is already taking place and can act as a great point of re-entry into a trade. However, it’s important to understand the dynamics of runaway gaps in order to have better entries.
- Runaway gaps tend to occur after a breakaway gap has already taken place
- They signal the continuation of the current trend and its strength
- A runaway gap can cause a stock to experience new highs or new lows in price
What is the Runaway Gap?
A runaway gap also referred to as a “continuation gap”, usually occurs in the middle of an uptrend or downtrend following a breakaway gap and is used as further confirmation of a trend. This gap occurs during strong bull or bear moves and will be identified by a significant change in price in the direction of the current trend. Runaway gaps will occur when the investor sentiment and interest are very high in a particular security.
Understanding Runaway Gaps in Trading
When a stock begins to trend, it may experience several periods of runaway gaps. The gaps are used as a way to confirm the overall strength of the trend. Once a runaway gap occurs, a stock will typically trend up aggressively and experience a temporary pull-back in price before the trend continues again. The pullback is usually due to traders taking profits from the quick move.
Technical analysts believe that a stock’s price will eventually return back to the price range where the gap occurs. The data about runaway gaps on this hypothesis is a bit unclear. Some believe that runaway gaps tend to NOT get filled the majority of the time unless it’s followed by a news event that is in opposition to the current trend.
Why Do Runaway Gaps Occur?
Runaway gaps occur due to further increased interest and demand for a security. They will most likely be seen after a breakaway gap has already taken place or once a stock hits a new high or low. It represents an almost FOMO-like mentality in retail traders which causes the price to gap above the previous day’s close.
Further news, a new partnership, or an unexpected company announcement can also cause runaway gaps to occur.
Properties of Runaway Gaps
- Strong trading volume
- New highs or lows being formed as a result of the gap
- Runaway gaps take a longer time to get filled
- Strong continuation of the current trend
Runaway gaps to the downside and runaway gaps to the upside do not always behave in the same way.
Runaway gaps to the downside will usually spike down aggressively in price and will be followed by a period of the stock recovering. This is typically due to institutional capital coming in to push the stock back up or short positions getting covered. These are usually short-lived before the stock continues further to the downside.
Runaway gaps to the upside tend to spike up aggressively and continue the trend up with small pullbacks in price before continuing to trend up.
Making Sense of Runaway Gaps
Once a gap occurs, at some point the stock or security will have a pullback in price. It may happen quickly or it may take some time, but a pullback will happen. Runaway gaps are extremely valuable for technicians and trend traders because they act as a strong signal for the change in the stock’s price from one trading session to the next.
In order to make sense of gaps, it’s important to consider a stock’s moving averages and RSI (relative strength index). It’s useful to know how far away the stock is currently trading above or below its moving average and RSI.
If a stock is trading significantly above or below its moving average or RSI, this can signal that the price of the stock has moved too aggressively in a short period of time and will eventually pull back to normal levels.
Runaway Gap Example (Upside)
As you can see, the runaway gap from our example above has a strong increase in volume, along with a strong continuation to the upside of it’s current trend.