Gap Trading: How to Play the Gap

what is gap trading

Think of a company like Gamestop, whose passionate investors drove the company’s shares past the $300 mark based on little more than their own excitement and emotional connection to the brand. This examination is especially important because of how much underlying research goes into gap trading. Traders spend a large amount of time researching specific stocks, their external catalysts, and how these circumstances could impact the stock’s price. But all of that research and data can make a trader feel as though a certain course of action is a sure bet – in reality, every trade comes with underlying risk.

what is gap trading

Selling all positions to liquidate holdings in the market is not uncommon. Likewise, if they happen during a bull move, some bullish euphoria overcomes trades, and buyers cannot get enough of that stock. The prices gap up with huge volume; then, there is great profit taking, and the demand for the stock totally dries up. Prices drop, and a significant change in trend occurs (see chart below for an example of an exhaustion gap).

However, before you decide to use this strategy, you must backtest your trading strategy and realize whether it is the right one for you. On that note, remember that some traders prefer to avoid volatile markets, which is usually the case with the gap trading strategy. As you can see in the Tesla daily chart above, price gaps occur quite frequently.

Traders should look for gaps that occur with significant volume, as this can indicate a strong move out of the trading range, either upwards (advancing) or downwards (declining). Some traders will fade gaps in the opposite direction once a high or low point has been determined (often through other forms of technical analysis). For paxful review example, if a stock gaps up on some speculative report, experienced traders may fade the gap by shorting the stock. Lastly, traders might buy when the price level reaches the prior support after the gap has been filled. The most profitable gap plays are normally made on stocks you’ve followed in the past and are familiar with.

Partial Gap Down: Long

A gap becomes “filled” when its price returns to the original, pre-gap level. For example, imagine a stock was trading at $32 per share before an overnight gap down occurred, dropping the price down to $27 per share. On a price chart, a stock’s daily price range is frequently shown by a graphical figure referred to as fxchoice minimum deposit a candlestick. A gap occurs when a stock opens at a price that is different to what it closed with the previous day, reflecting an unexpected change in price overnight. Just as prices can go up and down, gaps can either be a “gap up,” meaning that the price has increased, or a “gap down,” where the price has fallen.

what is gap trading

This is often used by the trader in intraday trade using a lower time frame price chart. The share market can be volatile and this results in frequent gaps in the market. Gapping most commonly happens overnight, although it can also happen during daily trading hours when there is a rapid jump in price of a stock. Stock gaps are caused by a number of reasons, such as earnings reports, news announcements and other economic indicators that lead to an increased supply and demand for the financial instrument. They are typically caused by stragglers jumping onboard late in a trend after having regretted not getting in earlier.

How to Trade Using FVGs – The Fair Value Gap Trading Strategy

Luckily, runaway gaps typically take a longer period of time to fill, so interested traders have more time to make a decision on how they want to trade on this type of gap. These gaps are typically changes of 5% or more, so the size of the gap can help a trader determine if they are looking at a runaway gap or a different type of gap. A trader could buy a stock if it gaps up at the open and sell it if it gaps down. For example, when a company releases positive news after market hours, this might result in a gap up that prompts traders to buy the stock with the expectation of a continual rise.

  1. Lastly, traders might buy when the price level reaches the prior support after the gap has been filled.
  2. But all of that research and data can make a trader feel as though a certain course of action is a sure bet – in reality, every trade comes with underlying risk.
  3. Gaps, such as stock gaps, are large jumps in a security’s price during non-trading hours due to external factors, such as news.
  4. Stock gaps are caused by a number of reasons, such as earnings reports, news announcements and other economic indicators that lead to an increased supply and demand for the financial instrument.
  5. The trader is punched out of their position at $25, not $22, resulting in an extra $3 per share loss.
  6. However, in some cases, the price may not move much yet and still end up as a full gap.

Locate the best entry point near the premarket high and exit once the shares begin to lose momentum. Fully gap-up occurs when the opening price of the stock is higher than the previous day’s high. Continuation or runaway gaps show an acceleration of an already bullish or bearish pattern in the same direction. This can be caused by a news event that confirms the sentiment and furthers the trend. Traders might look to follow the trend and place a stop just below the gap for a bullish runaway gap and just above for a bearish runaway gap. Interested gap traders will frequently run into discussions of “filled” gaps, causing confusion for newer traders.

Further reading on trading stocks and the stock market

Understanding how support and resistance can help us predict when or if a gap will fill. It’s also important to understand because gaps can increase the volatility of support and resistance levels. The type of gap that you could benefit from will largely depend on your financial situation and investment goals.

Still, if you master your skills in this area, gap trading offers many opportunities. The gap and go is one of the most popular trading strategies you can find. Technically, most traders who utilize this technique use pre-market scanners or pre-market gappers and focus on the first hour, or even less than that, following the market’s opening.

We do not manage client funds or hold custody of assets, we help users connect with relevant financial advisors. Benzinga Pro is a financial news and research platform developed in and delivered from Benzinga’s headquarters in Detroit, Michigan. Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism. She has worked lexatrade review in multiple cities covering breaking news, politics, education, and more. Thomas J Catalano is a CFP and Registered Investment Adviser with the state of South Carolina, where he launched his own financial advisory firm in 2018. Thomas’ experience gives him expertise in a variety of areas including investments, retirement, insurance, and financial planning.

These gaps are common (get it?) and usually get filled fairly quickly. Your take-profit target should be set just above the next demand zone in the direction of your trade. This zone represents a likely point where the market could reverse, allowing you to secure your profits. However, you can use this level to extend your earnings in case you notice a significant trend that is about to break the support level.

Traders might interpret this as a signal to continue holding or even adding to their positions. The available research on day trading suggests that most active traders lose money. It has the trading indicators, dynamic charts, and stock screening capabilities that traders like me look for in a platform. It also has a selection of add-on alerts services, so you can stay ahead of the curve. Starting from the left, we can see a bullish engulfing line, suggesting the move lower may be reversing (candlestick analysis).

Customers seeking educational material on gap trading should look for YouTube content that provides clear explanations and practical examples. The content should cover various aspects of gap trading, from basic concepts to advanced strategies, and ideally include real-world examples and results. It should also align with the customers’ trading objectives and skill level. Set clear stop losses to mitigate potential losses, and don’t risk more than a set percentage of your account on a single trade. Also, diversify your trades across different sectors and asset types, like ETFs and forex, to spread risk.

The good news for interested gap traders is that breakaway gaps don’t typically fill quickly. Let’s break down how you might be able to take advantage of this strategy for your portfolio. You could also benefit from working with a financial advisor to help make smart investment decisions for your financial goals. Now, apart from the cryptocurrency market, all other markets have opening and closing times. The forex market, for instance, is open 24/5 and is closed on Saturday and Sunday. Therefore, in forex trading, traders can find price gaps when the market opens on Monday.

Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.