What Are Gaps in Trading?

A gap happens when a stock opens at a different price than where it closed the day before, leaving a blank space on the chart with no trading activity in between. Gaps can go in either direction: up or down.

Let’s say a stock closes at $50 on Tuesday. If it opens at $53 on Wednesday without any trading between $50 and $53 during regular hours, that’s a gap up. If it opens at $47 instead, that’s a gap down.

These gaps show sudden shifts in price that happen outside of normal trading hours, usually during pre-market or after-hours trading.

Why Do Gaps Happen?

Gaps occur because of sudden price changes when the market is closed. These shifts are often driven by new information that comes out after the previous trading day ends.

Here are a few common reasons:

• Earnings reports
  
• Economic news
  
• Major company announcements

For example, if a company announces strong earnings after the market closes, buyers may rush in during after-hours trading, pushing the stock price higher by the next morning.

Not all gaps have a clear reason, though. Sometimes stocks gap up or down for no obvious reason. These are called “common gaps,” and they’re usually not worth trading.

How Gaps Help Traders

Gaps can give us clues about market sentiment. When a stock gaps up, it can show bullish strength. When it gaps down, it may reveal bearish pressure.

But here’s the key: gaps don’t always lead to follow-through. A stock might gap up and then sell off, or gap down and rally back up. That’s the reason behind the gap, and the type of gap matters so much.

Gaps also create important price levels on the chart. These zones can act like support and resistance, giving traders clear areas to plan trades.

Types of Gaps

There are four main types of gaps. Knowing how to spot them helps you understand whether a gap is worth trading or best left alone.

1. Common Gap

This is the most frequent type of gap and usually has no strong news behind it. You’ll often see them in choppy, sideways markets. These gaps tend to fill quickly, meaning the price often comes back to where the gap started.

Since common gaps aren’t based on anything meaningful, they usually don’t offer solid trading opportunities.

2. Continuation Gap

A continuation gap appears in the middle of a trend and confirms that the trend still has momentum. If a stock is moving up and then gaps higher with strength, it could be a sign that the uptrend is continuing.

These gaps often happen during healthy price action and are backed by news or earnings. They can offer high-quality trade setups, especially when the price continues to move in the same direction.

3. Exhaustion Gap

An exhaustion gap shows up at the end of a strong trend and can signal that the trend is running out of steam. It’s like the last push before price reverses.

Imagine a stock that’s been climbing for days, then suddenly gaps up with a weak-looking candle. If it fails to move higher after the gap, it may be time for a pullback or reversal.

Exhaustion gaps often come with signs like rejection candles or lack of follow-through, warning that buyers (or sellers) are getting tired.

4. Breakaway Gap

This is one of the most powerful types of gaps. A breakaway gap happens when the price jumps above resistance or drops below support. It usually signals the start of a new trend or a major shift in momentum.

These gaps are often caused by strong news or earnings and can lead to big moves. If the gap holds and volume supports the move, it may be a great opportunity to ride the new trend.

What Is a Gap Fill?

A gap fill happens when the price moves back to the level it gapped from. For example, if a stock gaps down from $60 to $55, and later climbs back to $60, the gap has been “filled.”

But not all gaps get filled, especially not right away.

Breakaway gaps often don’t fill for a long time, or ever, because they represent real momentum and trend changes. On the other hand, common gaps have a higher chance of filling quickly since there’s no strong force keeping the price away from the original level.

Don’t just assume a gap will fill. You need to understand the gap type, volume, news, and overall market conditions before making a trade based on a gap fill.

Key Questions to Ask Before Trading a Gap

Before you decide to jump in, ask yourself:

1. What kind of gap is this: common, continuation, exhaustion, or breakaway?
   
2. Why did the stock gap? Was there a real catalyst?
   
3. How does this gap fit into the overall context, trend, levels, and market conditions?
   

Understanding the story behind the gap helps you decide whether it’s worth trading or better to ignore.

Key Takeaways

• A gap occurs when a stock opens at a different price than it closed the previous day, creating a blank space on the chart.
• Gaps are caused by after-hours news, earnings, or other catalysts, but not all gaps have a clear reason.
• There are four main types of gaps: common, continuation, exhaustion, and breakaway, each signals something different.
• Common gaps usually fill quickly and aren’t based on meaningful events; breakaway gaps often lead to new trends.
• Gap fills happen when price returns to the level it gapped from but not all gaps fill.
• Always consider the gap type, volume, and market context before trading a gap.
• Gaps can signal strong opportunities or traps, understanding the story behind the gap is key.