In some cases, shares open at the same price they closed during the previous day’s trading session. In other cases, the opening price of a share may differ from the previous day’s closing price. In some cases, this difference can be explained by extended hours trading, but in other cases, there is something else at play.
What is a price gap on a stock?
A price gap occurs when a stock opens at a significantly different price than it closed the previous day despite not much trading between sessions. A price gap can occur in an upward direction, with the stock in question opening at a price significantly higher than its previous close (this is called a bullish gap), or in a bearish direction, with the stock in question opening significantly low than its previous close (this is called a bearish gap).
In many cases, price gaps are accompanied by higher than usual trading volume during the sessions immediately before and after the gap.
What causes price gaps?
Price gaps are generally caused by a change in market sentiment towards a stock as a result of pertinent news being released between market sessions. In many cases, posting a quarterly earnings report after hours or before trading is to blame.
What does it mean when a gap is closed or filled?
In many cases, the stock price pulls back towards and/or goes through a price gap shortly after that gap occurs. In some cases, this occurs during the trading session immediately following the gap, while in other cases, the gap-filling process can take days or weeks.
In some cases, the gaps are not filled. When a bullish gap is not filled, the top of the gap often becomes a major support level for the stock in question. Similarly, when a gap is not filled to the downside, the bottom of the gap often becomes a major resistance level.
What are the 4 types of price gaps?
Price gaps generally fall into one of four categories based on their characteristics and what happens after they occur.
common gaps
Common gaps are, as the name implies, relatively common. They tend to occur within established trading ranges and are generally not significant. As for gaps, common gaps are the least useful type in terms of trading opportunities and tend to indicate a lack of interest in stocks.
breakout gaps
When a price gap “jumps” an established support or resistance level, it is called a gap breakout. This is similar to a normal breakout except that the breakout occurs over extended hours in the form of a gap.
Out-of-control breaches
Out-of-control gaps occur during an uptrend or downtrend and represent action by traders who were late to act on that trend. In other words, they occur during a trend between the two main trading sessions in which that trend occurs.
depletion gaps
Exhaustion gaps are those that occur at the end of a long-term up or down trend. They are easily identifiable in hindsight as they precede a reversal. For this reason, depletion slots usually fill up very quickly after they occur due to reversal.
How do traders take advantage of price gaps?
Many traders try to take advantage of price gaps by trying to identify what type of gap is taking place before any subsequent action takes place. For example, since common gaps and exhaustion gaps usually fill, traders who believe they have identified one can bet that the stock in question is heading in the opposite direction in the short term.
If a trader believes they have identified a runaway breakout or gap, on the other hand, they might make moves in the direction of the gap in an attempt to capitalize on its trend.
