Stock gaps are areas on a chart where the price of a stock moves sharply in price in either direction with little to no trading between the previous session or time frame. In periods of high volatility, traders can experience large moves in asset prices in either direction.
These large moves can present trading opportunities and also pose some serious risks. In this article, we will learn how and why stock gaps occur, the different types of stock gaps and how you can interpret them to make a profit.
- Gaps occur due to changes in underlying fundamental and technical factors
- Stocks gaps are areas on the chart in which a stock or financial instrument opens higher or lower than the previous close
- The four different gaps are common gaps, breakaway gaps, runaway gaps, and exhaustion gaps
- Stock gaps most commonly occur after the market closes and reopens the next day
Stock Gaps Explained
As we already mentioned stock gaps are areas on a chart in which very little to no trading takes place. Stocks or other financial instruments will open higher or lower than they previously closed. They occur unexpectedly due to fundamental or technical factors.
The real question is why do stock gaps occur in the first place? Let’s take a look at some of the most common reasons why stock gaps occur.
- Higher than-expected earnings releases
- Lack of liquidity in the stock
- Mergers and Acquisitions
- Interest rate announcements
- Stocks being re-opened for trading after a halt ( this can happen intraday )
Other complicated reasons can cause stock gaps, but they are more of a rare occurrence. This can include end-of-day buying to close out stock positions, options contract assignment, and institutional portfolio rebalancing.
These reasons are rare and cause traders to buy and sell large blocks of stocks late into the day or after the market has closed.
When Do Stock Gaps Usually Occur?
A stock gap occurs once the market closes for the trading session (4:00 PM EST) and reopens the next day (9:30 AM EST) higher or lower from the day before. There is still buying and selling of the stock that can occur after the market closes which is referred to as after-hours trading. There is also buying and selling of the stock that can occur before the market opens.
The after-hours and pre-market hours trading can create a buying and selling frenzy which can trigger the price of the stock to open up much lower or higher. Now that we know when stock gaps occur and what can cause them, let’s take a look at the different types of stock gaps that exist
Different Types of Stock Gaps
Stock gaps are broken down into the following 4 types:
- Common Gaps are occasional price gaps found on the charts of a particular trading instrument. They are the by-product of normal market behavior and they don’t necessarily follow any given pattern. They are as the name implies, common, and occur as a result of normal trading activity.
- Breakaway Gaps are price gaps that signal a strong price move through technical support and resistance levels. They are used heavily by technical analysts to spot the end of a price pattern and the start of a new trend.
- Runaway Gaps, commonly referred to as “continuation gaps“, occurs in an existing trend and signal a continuation of that trend. The location of the gap can be used to predict a certain price target.
- Exhaustion Gaps signal that the strength of a trend is beginning to weaken and in some cases even reverse. They occur towards the end of a price pattern and usually at points in which a trend attempts to make a final attempt to hit new highs or lows. You will see either massive buying or selling occurring during exhaustion gaps.
What Does it Mean When a Stock Fills a Gap ( “To Fill The Gap” )
A common phrase that you might hear when gaps get referenced is the phrase “to fill the gap”. When a stock gap has been filled, it means that the price of the stock has returned to the pre-gap level price. It’s estimated that 90% of stock gaps get filled. Gap fills are pretty regular and occur due to some of the following reasons below.
- Technical Support or Resistance: When the price of a stock moves up or down aggressively without any support or resistance close by.
- Patterns: Price patterns are a good way to judge whether or not a gap will be filled. They are also a good way to classify gaps. If you become good at classifying gaps you can have a better idea if they will get filled or not.
- Irrational exuberance: This is a term that refers to the strong belief or enthusiasm of traders about a certain stock that ends up driving the prices higher than what fundamentals suggest. It is the blind optimism of traders that can often time be caused as a result of overexcitement and FOMO.
What Does it Mean When a Stock Doesn’t Fill The Gap (“Not to Fill The Gap” )
When a stock fails to fill the gap it means that the price of the stock didn’t return to its pre-gap level price. This can happen when a stock is in a strong uptrend and significant buying continues to push the stock to new highs.
Is it good when a stock gaps up?
Gaps that open up are typically considered a bullish indication. This means that buyers are in control of the price and have positive optimism about the future of the stock.