Understanding market gaps: The practical guide to a gap

When prices open disconnected from the previous close, without intermediate transactions, we are dealing with what we call a gap. For new and veteran traders, these sharp movements can be surprising, but understanding them is essential for successful trading in the stock market.

What is a gap in stock trading

A gap represents a discontinuity in the price chart where no trading activity occurs. It happens when a stock or financial instrument jumps sharply up or down, opening at a level very different from the previous close. This phenomenon creates a visual void in candlestick charts, indicating an accelerated market movement.

The four types of gaps you will find in trading

There are different types of gaps, each with particular characteristics:

Common gaps: Simply show a gap in price dynamics, without predictable patterns. They rarely offer solid trading opportunities.

Breakaway gaps: Indicate that the asset “breaks away” from the previous trading pattern. When accompanied by high volume, they represent potential opportunities for long (in bullish gaps) or short (in bearish gaps) positions.

Continuation gaps: Accelerate an existing movement, confirming the market direction. Novice traders should place stop orders just below the gap for upward gaps and just above for downward gaps.

Exhaustion gaps: Mark the end of a trend. Unlike continuation gaps, the price rises into overbought territory and then reverses. Advanced traders take advantage of this point by taking contrarian positions.

Why do these movements happen in the stock market?

Gaps result from imbalances between supply and demand. When there is aggressive buying, the gap moves upward; with sales exceeding supply, it moves downward.

After-hours news is a common catalyst: product announcements, executive appointments, or corporate updates generate overnight sentiment changes that explode at the open. The market buzz drives investors to act en masse, moving prices significantly between sessions.

Large investors also create gaps when trying to pass critical support or resistance levels, generating enough volume to cause breakouts.

Full gap versus partial gap: The difference in risk and reward

A full gap occurs when the opening surpasses the previous day’s high. For example: if ABC closes at USD 39 with a high of USD 41, but opens the next day at USD 42.50, that is a full gap.

A partial gap happens when the opening is between the previous close and the prior high. If the same stock ABC opens at USD 40, it is partial (above USD 39 but below USD 41).

The importance lies in what these reveal about market pressure. Full gaps indicate strong conviction from buyers or sellers, promising prolonged movements. Partial gaps suggest moderate demand.

Why bullish gaps attract traders

An upward gap attracts significant volume, indicating institutional or retail buying en masse. However, determining whether it is temporary or the start of a trend requires careful analysis.

To identify them, use filters on trading platforms. Look for stocks traded with high volume (exceeding 500,000 shares daily on average). Examine long-term charts for clearly defined support and resistance zones.

Japanese candlesticks clearly represent these gaps: the color and composition reveal the strength and direction of the movement. Upward gaps are particularly common during dividend distribution periods.

Strategies for successful trading with gaps

Day traders start their day before the opening bell, observing signals in the hours prior. Technical tools help identify profitable targets for the day’s trades.

Analysis requires basic knowledge of chart representations. Study the fundamental factors behind each gap and correctly recognize its type. Traders who take time for this analysis trade with higher probabilities of success.

Watch the volumes: volume reductions indicate exhaustion gaps, while breakouts go with high volumes. Although these gaps can be misleading, waiting for market confirmation ensures educated decisions.

Gaps can signal the start of a new trend, the end of a previous one, or the continuation of the current trend. Since analysis is retrospective, it works reliably in systematic trading strategies.