What Is Gapping?

What Is Gapping?

Let me explain gapping directly: it happens when the price of a stock or another asset opens above or below the previous day's close, with no trading activity in between. You see this as a discontinuity on the price chart. These gaps often appear because of headlines that rapidly change market fundamentals during off-hours, like an after-hours earnings report.

Gapping can also mean the spread in rates for banks borrowing and lending. The dynamic gap tracks how assets and liabilities shift over time.

Key Takeaways

You need to know that a gap forms when the opening price is far from the previous close, with nothing traded in the middle. Common gaps are usually partial, while breakaway, runaway, and exhaustion gaps are often full. A full gap means the open is completely outside the prior day's range. Each gap type signals something specific to traders. Since common gaps are small and frequent, they don't offer much analytical value.

Understanding Gapping

Gapping shows up in any instrument that closes and reopens for trading. Stocks do this daily. Currencies trade around the clock during the week but can gap over weekends.

Gaps can be partial or full. Partial means the open is higher or lower than the close but still within the previous day's range. Full means it's outside that range. A full gap, especially, indicates a major sentiment shift overnight.

Types of Gapping

Different gaps depend on size and trend position. They can be full or partial. Common gaps are mostly partial with minor moves, but sometimes full even without big shifts. Breakaway, runaway, and exhaustion gaps are usually full.

Common Gaps

Common gaps happen often and mean little. The open is just slightly off from the prior close, with no big move during or after, confirming it's common.

Breakaway Gaps

A breakaway gap breaks above resistance or below support. It can follow a tight range or chart pattern exit. This signals a strong trend start, usually large, with price following through for weeks.

Runaway Gaps

Runaway gaps appear in strong trends, showing the trend's power. In retrospect, they're mid-trend as momentum builds. They're large, and price keeps going in that direction for weeks.

Exhaustion Gaps

Exhaustion gaps come near trend ends, from late buyers jumping in. After the gap up, few buyers remain, leading to a reversal soon after.

Gapping and Stop Loss Orders

Gaps can fill your stop-loss way below your set price in a long position. For instance, buy at $50 with stop at $45, but bad news opens at $38—your order fills there. Avoid trading before big announcements to cut risk. Shrink positions in volatile times.

Short positions can gap against you too, like short at $20 with stop at $22, but news opens at $25, filling at that price for extra loss.

Gapping Trading Strategies

Some traders analyze gaps: early in a trend, it might be breakaway or runaway, suggesting more movement ahead.

Others trade post-gap, known as playing the gap.

Buying the Gap (Up)

This is the 'gap and go' for day traders. Enter long on gap day, stop below gap low. Gap should be above resistance on high volume. Or wait to fill gap and buy near prior close.

Selling the Gap (Down)

Similar, but short after gap down.

Fading the Gap

Contrarians fade by trading against the gap, betting it fills. For gap up, short with stop above high, target prior close. For down, buy with stop below low.

Gaps as an Investing Signal

Breakaway and runaway gaps signal trend continuation, so enter in gap direction. Hold until exhaustion gap or trailing stop hits.

Tip

Gaps tie into candlestick patterns, like Up/Down Gap Side-by-Side White Lines or Upside Gap Two Crows.

Example of Gapping

Stocks vary in gap frequency, but all can gap on earnings or news. Market moves can cause widespread gaps. Meta's chart shows big gaps from earnings, plus others. Gaps don't always follow trends; a counter-trend gap can signal reversal, like Meta's drop from $217.50 to $174.89 overnight, costing 20% even with stops.

What Volume Should a Gapping Stock Have?

High volume on gap confirms direction continuation, like for breakaway. Low volume suits exhaustion.

What Is a 'Gap and Go' Strategy?

It's buying a gap up, bullish, with stop below gap bottom.

How Do You Know If a Stock Will Gap Up?

You can't predict perfectly, but positive surprises like good earnings, takeover news, or product launches often cause gap ups.

Disclaimer

This isn't tax, investment, or financial advice. Information doesn't consider your objectives, risk, or circumstances. Investing risks principal loss.