How to know if a stock will gap up or gap down: The Stock market consists of numerous opportunities where you can earn good returns. But it can be difficult to predict what will happen in the market the next day.
There are times when you can surely foresee the anticipated movement in the price of share or Index. But before you can jump in to take the opportunity, the markets or stock would have already been there. How does that happen? It is because the market opens with a Gap.
In this article, we will be covering how to know if a stock will gap up or gap down and how you can use these gaps to your advantage in the stock market.
What Are Gap Openings?
A gap opening in the stock market means, a Stock or an Index opening above or below the closing price of previous trading day.
A stock is said to have a Gapped up when it opens above the closing price of the Previous day.And, the marekt is said to have gapped down when the price of the stock opens below the Previous day closing price.
A Gap Up or Gap Down shows the interest of involved parties (buyers and sellers) and the probable movement of the prices in foreseeable future.
Is A Gap Up Bullish?
Gap-ups are generally considered bullish while Gap downs are considered bearish. These gaps are a result of the extraordinary buying or selling interest developing while the market is closed.
Now that we have understood the meaning of Gap openings, let us cover how to know if a stock will gap up or gap down.
How To Know If A Stock Will Gap Up Or Gap Down?
While it is certainly impossible to predict the movement in the market, but there are certain situations wherein you can predict the gap openings in the market.
The situation where you can confidently predict the gap movement is when there is news relating to the market or stock after trading hours. If the news turns out to be positive, the markets or stocks will result in a gap up and there will be a gap down opening in case of negative news.
Another factor that determines the movement in the market is the international market. The Indian market will often react to noticeable movements in the US market and the US market opens after the closing of the Indian market. So if the US market has made a huge movement on either direction, there is a good chance that the Indian Market will more than likely Gap (up or down) in that direction.
Though we cannot take advantage of the gap itself, but we take advantage of the gap filling up and also predict the future movement using different types of gaps. Let us cover each of these, one by one.
Filling Of The Gap
Whenever the market tends to have a huge gap opening, the gaps sometimes tend to fill up during the trading day. The filling of the gaps can be due to individuals squaring off the positions or a large inflow of buyers buying new position and sellers exiting their shorts.
(Image: Nifty 15 mins chart on)
If we take a look at the chart above we can see that Nifty 50 had opened gap down due the fall in the international markets. But, because the overall sentiments in the Indian markets were bullish, Nifty 50 covered the gap and reached the previous day closing price.
While this can be true many times, it might not always be the case. The market or stock might even move in the direction of the Gap.
Types of Gaps
Gap openings can be categorized into four types that can help us understand the future trend in the market or a share. Let us look at each of these gaps.
1. Common Gaps
Common gaps are also referred to as trading gaps or area gaps. These gaps occur due to regular market forces and do not require any special event. These gaps are generally smaller in size and get filled up quickly. The markets go back to its original levels in a few days or weeks after these gaps.
2. Breakaway Gaps
Breakaway gaps form at the end of the stock pattern. It can be used to indicate either a breakup or a breakdown. In either condition, it indicates a fresh pattern or the beginning of a new direction.
In the above chart, you can notice that the security was trading in a range after a bearish trend. But after the gap up opening in the next session, there was a new bullish trend in the security. This indicated that the buyers were now interested in buying the security
In the above chart, you can see that the security was in sideways zone after an uptrend. After a Gap down in the market, we see fresh bearish momentum in the market. This indicates that the seller have an upper hand over the security
3. Exhaustion Gap
While the breakaway gap represents a new emerging trend, an exhaustion gap represents the end of a trend in the security and indicates the security’s final attempt to make a new high or low. This pattern indicates a reversal pattern
In the above chart, you can see that security is getting continuously sold and the exhaustion gap is the final stretch of the sellers to push the price down. At this point, the buyers start entering the security and push the price up.
The above chart indicates that a huge influx of buyers entered the security and the exhaustion gap is the final stretch of the price moving upwards. After this point, the holders/buyers start realizing profits or fresh sell positions get initiated, which will bring the price down
4. Continuation Gap
A continuation gap is a gap that occurs in between the existing trend in the market. This gap gives confirmation to the already existing trend in the security, This denotes a consensus among the buyers or sellers on where the stock should be headed.
From the above chart, you can see that there is already an upward trend in the security and due to the increased interest of the buyers, the security gaps up and gives more conviction to the trend.
From the above chart, you can see that the security is in a downward trend and due to the increase in the number of sellers, the security gaps down indicating a further downtrend in the future.
Also Read: What is Higher High Lower Low Strategy in Trading?
In Closing
In this article, we discussed what are gap openings, how to know if a stock will gap up or gap down, filling the gap and different types of gaps.
Getting familiar with gaps can help go a long way in technical analysis. The gap analysis is simpler than it looks. They indicate the start of a trend, its end, or its continuation and can help you consistently earn a good amount of money by providing important input for your trading decision.
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