An unfilled space or area of discontinuity on a stock chart where no trading has taken place is called a gap. It is a space where the stock price rises or declines from the previous day’s close, but with no trading having taken place during the gap period.These gaps are the result of a news or an event leading to a change in market fundamentals. Typically, this happens when the market is closed. Such news or event can be about anything that bears a significant impact on the stock price and influences the buyers and sellers of a stock. Merger and acquisition (M&A), post-market hours earnings call, or change in top management personnel are examples of such events.A gap results in the stock price opening considerably higher or lower than the previous day’s close. A gap may indicate the start of a new trend or reversal of the previous trend, depending on its kind.When the opening price of a stock is higher or lower than the previous day’s close, but is within the previous day’s price range, it is called partial gapping. On the other hand, when the stock opens outside the previous day’s trading range, it is a full gapping. A full gap signifies a strong shift in sentiment.In an uptrend, a gap occurs when the highest price of the stock on a day is lower than the lowest price of the next day. On the contrary, in a downward trend, a gap is produced when the lowest price of the stock on a day is higher than the highest price of the following day.
Suppose, the price of a stock touches a high of Rs 210 on Tuesday, and opens at Rs 250 on Wednesday, falls down to Rs 240 during the day, and then moves higher to Rs 255. Here, no trading has taken place in the area between Rs 210 and Rs 240. This no-trading area appears as a gap on the chart.
Types of gaps
Generally, there are four types of gaps. These are Common Gaps, Breakaway Gaps, Runaway Gaps, and Exhaustion Gaps.A common gap, also known as a trading gap or an area gap, is usually uneventful as no major event precedes this gap. These gaps generally get filled relatively quickly and tend to be complemented by normal average trading volume.
A breakaway gap takes place at the end of a price pattern or when the price breaks out of a trading range through a gap. A breakaway gap signals the beginning of a new trend.Runaway gaps, also called Continuation gaps, are caused by a sudden increase in investors’ interest in a stock. These gaps occur in the middle of a price pattern and are derived from a significant rise in trading volumes.Exhaustion gaps occur near the end of a price pattern. They signal the end of the prevailing trend and are identified by huge volumes and a large price difference between a day’s close and the opening price the next day.
Filling the gaps
When the stock price moves back to its original pre-gap level, the gap is said to have been filled. Breakaway gaps and runaway gaps generally have lower chances of getting filled. This is because it is assumed that these gaps are formed due to events that have strong directional momentum. Thus, trading a gap-fill equals trading against this momentum and the newly formed trend.When a gap gets filled on the same trading day on which it occurs, it is called fading.The filling of gaps happens because of many reasons. The first is due to irrational exuberance, which means that the initial spike in stock price might have been very optimistic or pessimistic, which then invites a correction.A gap-fill also occurs due to technical resistance, that is, when the price of a stock rises or falls sharply, it does not leave behind any support or resistance.Gaps matter a lot in profit or loss from a trade. It is important to note that if a trader is unable to identify a gap and react to it, he is likely to miss the opportunity to get in or out of a good trade.
