How To Trade Gaps Successfully: Individuals always look for opportunities that can help them earn profits in the stock market and there are times when you can foresee the anticipated move in the security.
But most of the time, these opportunities miss in our hands as security tends to make a gap opening. For this reason, in this article, we will be discussing how to trade gaps successfully in the stock market.
What Are Gap Openings?
A gap opening is a break in the prices of the security that occurs between the closing and opening sessions of consecutive days. In simpler terms, a stock or an index will open below or above the price it closed at during the previous trading day.
When security has opened above the closing price of the previous trading day, it is considered a gap-up opening. When security has opened below the closing price of the previous trading day, it is considered a gap-down opening.
A Gap opening indicates the likely interest of buyers and sellers in the market. A gap down in the market indicates the sellers have more interest while a gap up indicates the buyers showing more interest.
Gaps occur in different forms and are categorized into different types in the market. Let us first go through these types of gaps before going through how to trade gaps successfully.
Types Of Gaps
These gaps can provide insights into market trends and potential trading opportunities. There are different types of gaps that traders and investors should be aware of.
1. Common Gaps
Common gaps also known as trading gaps or area gaps appear in security due to regular market pressure and do not require any special events to take place. These gaps are often small in size and tend to get filled quickly. Security tends to revert back to its previous levels only a few trading sessions after the occurrence of this type of gap.
2. Breakaway Gaps
Breakaway gaps occur upon the end of a significant price pattern and indicate a significant movement in the price of the security. It appears when the price of the security opens above a resistance area or below a support area from a well-established trading range through a gap.
A bullish breakaway gap occurs when a security opens above the previous day’s closing price which causes an end of the sideways movement in the price of the security and begins an upward trend.
A bearish breakaway gap occurs when a security opens below the previous day’s closing price which causes an end of the sideways movement in the price of the security and begins a downward trend.
3. Exhaustion Gap
Exhaustion is an indication of the final stretch in the price of the security. It is a gap opening in the direction of the current trend in the market which indicates the final attempt of the buyers or sellers to push the price in their favor. After the emergence of this gap, security tends to take a reversal from the existing trend.
A bullish exhaustion gap occurs when the security has opened the gap down from the existing downtrend and the price starts moving upwards in proceeding trading sessions.
A bearish exhaustion gap occurs when the security has opened the gap up from an existing uptrend and the price starts moving downwards in proceeding trading sessions.
4. Continuation Gap
A continuation gap also referred to as a runaway gap appears in the middle of the upward or downtrend and continues in the direction of the trend. This gap indicates a strength of the buyers or the sellers on the existing trend in the market.
When the security opens a gap up from an existing uptrend and continues in the upward direction, it is called a bullish continuation gap.
A bearish continuation gap is when the security opens a gap down from the existing downtrend and continues the downward trend
How To Trade Gaps Successfully?
Though the types of gaps that appear in the market are categorized into various, trading using these gaps can be a difficult task. A reason for saying this is, the type of gap can be confirmed only after the price has made its complete movement.
By this time, it is often too late to take an entry into the market due to which it is best to avoid trades using these gaps. But on the bright side, there are other ways to trade using the gaps in the market.
1. Filling Of The Gap
The first method how to trade gaps successfully is to use the filling of the gaps. Generally, when security makes a huge gap opening, it tends to fill up the gap during the day. This can be due to a large number of market participants taking up a buying position or a huge number of participants squaring off their positions.
When security makes a huge gap up opening, it tends to fall to the levels of the previous day’s closing price. This is a good opportunity for individuals to enter a short position in security.
When security makes a huge gap down opening, it tends to rise to the levels of the previous day’s closing price. This is a good opportunity for individuals to enter a long position in security.
Below is an example of the price of Nifty opening gap down and filling up during the day.
(Image: Nifty 15 mins chart on)
Though this price movement can occur the majority of the time, there is no certainty of its work every time. Thus, it is important to keep a stop loss a few levels below the security’s closing price if it has gapped up and vice versa
2. Using Gaps For Support & Resistance
The second method how to trade gaps successfully is to use the gaps as support and resistance levels.
When the stock gaps up, you can use the range of the gap as a support level and enter a long position in the security. The stop loss here should be below the levels of the previous day’s closing.
When the stock gaps are down, you can use the range of the gap as a resistance level and enter a short position in the security. The stop loss here should be above the levels of the previous day’s closing.
The closer the price is to the previous day’s closing levels, the better it is to enter a long or short position in that security, as the price tends to reverse from these levels.
Also Read: Most Accurate Leading Indicators – Pros, Cons & More!
In Closing
In this article, we discussed what are gap openings, the types of gaps, and how to trade gaps successfully.
Learning how to trade using gaps can help you earn good profits in the stock market. But individuals should also be aware the above-mentioned strategies may not work every time, which is why it is important to have proper risk management which can help you minimize your losses.
Tags: Is gap trading profitable?, How to do gap trading?, Do trading gaps always get filled?, How do you trade gap and go strategy?, Overnight gap trading strategy, How to predict gap up and gap down, Gap down opening strategy, Nifty gap up gap down strategy, How To Trade Gaps Successfully, GAP Trading Strategy with Examples