What Is a Stock Gap?
Let me tell you directly: a stock gap is a discontinuity in a security's price on a chart, typically triggered by significant news or events happening outside regular trading hours. These gaps can point to potential changes in the market, and if you understand the four types—common, breakaway, runaway, and exhaustion—you'll be better equipped to make decisions as a trader.
Key Takeaways
- A stock gap is a discontinuity in a security's price chart that occurs when the price jumps higher or lower from the previous day's close without trading in between.
- The four main types of gaps are common gaps, breakaway gaps, runaway gaps, and exhaustion gaps, each carrying distinct implications for market trends.
- Traders may use gap analysis to identify potential buy or sell opportunities, but misinterpreting the type of gap can lead to significant financial mistakes.
- Gaps often occur due to news or events affecting market sentiment, and many gaps get filled as prices adjust back to pre-gap levels.
How to Interpret Stock Gaps
You need to know that gaps usually happen when news or an event floods the market with buyers or sellers for a security. This causes the price to open much higher or lower than the previous day's close. Based on the gap type, it might indicate the beginning of a new trend or the reversal of an existing one.
Gapping takes place when a security's price opens far above or below the prior day's close with no trades in between. There's partial gapping if the open is higher or lower but still within the previous day's range, and full gapping if it's outside that range. A full gap especially shows a major overnight shift in sentiment.
Some traders build strategies around profiting from these gaps when they appear. But remember, even though gaps are straightforward to spot, the big limitation is your ability to correctly identify the type. If you get it wrong, it could be a costly error, leading you to miss buying or selling chances that impact your profits and losses.
Exploring the Different Types of Stock Gaps
There are key differences among the types of gaps: common, breakaway, runaway, and exhaustion. Let me break them down for you.
A common gap doesn't usually follow a major event and tends to fill quickly, often within days, compared to others. They're also called area gaps or trading gaps and come with average trading volume.
A breakaway gap happens when the price gaps above a support or resistance level, like in a trading range. When it breaks out of an established range via a gap, that's breakaway, and it can also emerge from patterns like triangles, wedges, cup and handle, rounded bottoms or tops, or head and shoulders.
A runaway gap shows up when trading skips price points due to strong investor interest, with no exchanges between the start and end of the gap.
An exhaustion gap signals a price break lower after a rapid rise over weeks, indicating a shift from buying to selling and possibly the end of an upward trend.
Each type impacts traders differently. Reversal and breakaway gaps often have high trading volume, unlike common and runaway ones. Most gaps follow news, earnings, or analyst changes. Common gaps are frequent and often fill without clear reasons, while others might signal trend changes or continuations.
Real-World Stock Gap Examples
Take Amazon.com Inc. (AMZN) as an example: between October 26, 2023, and October 27, 2023, there was a small gap where the price jumped from $119.57 to $127.74. This reversed a downward trend, and the price kept climbing afterward.
Another case is Alphabet Inc. (GOOGL): from October 24, 2023, to October 25, 2023, the price fell from $138.81 to $125.61 after weeks of increases. But the drop didn't continue downward; instead, the price rose back to fill the gap.
Why Do Stock Gaps Fill?
Stock gaps form from large price jumps after market close, often due to news. When a gap fills, the price returns to its pre-gap level, which happens frequently as the market settles after initial overreactions from buying or trading.
What Is Price Gap Risk?
Price gap risk is the chance that a security's price will drop or rise sharply from close to open without any trades in between. You should prepare for this by closing positions at day's end or using stop-loss orders.
How Often Do Stocks Gap?
How often stocks gap depends on your trading time frame. Shorter frames like daily charts show more gaps than longer ones like monthly charts.
The Bottom Line
Stock gaps occur when an asset's price jumps between sessions due to news or events, creating a chart discontinuity. These can signal trend starts or reversals based on type. You must identify them correctly—whether common, breakaway, runaway, or exhaustion—and understand their causes to avoid mistakes. Strategies might involve trading the gap or using stop-losses for risk management. Grasping these helps you respond to market changes effectively.
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