Gapping

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Gapping: Definition, Types, and Trading Strategies

Gapping occurs when an asset opens at a price materially different from the previous close, with no trading in between. On a price chart, the empty space between the prior close and the new open is the gap. Gaps commonly happen after news or events that occur while markets are closed (earnings, corporate announcements, macro data) and can signal a sudden shift in sentiment.

Key points

  • A gap is the difference between a security’s opening price and the previous closing price with no intermediate trading.
  • Gaps can be partial (open inside the prior day’s range) or full (open outside the prior day’s range).
  • Types of gaps—common, breakaway, runaway, exhaustion—carry different implications for trend direction and trade planning.
  • Gaps can trigger large slippage on stop-loss orders; risk controls are important.

Understanding gaps

  • Partial gap: the open is above or below the prior close but still within the prior day’s high–low range. Often less significant.
  • Full gap: the open is outside the prior day’s range and generally indicates a stronger overnight sentiment shift.

Gaps can occur in any instrument that closes and reopens, including stocks and weekend-closed FX markets.

Types of gaps

  • Common gap
  • Small, frequent; usually insignificant for trend analysis.
  • Breakaway gap
  • Occurs when price gaps beyond a clear support or resistance level or breaks out of a tight trading range or chart pattern.
  • Often signals the start of a new trend; typically accompanied by higher volume.
  • Runaway (continuation) gap
  • Appears in the middle of a strong trend and indicates the trend’s momentum is continuing.
  • Exhaustion gap
  • Appears near the end of a trend, often after a final surge of participants. Usually followed by a reversal within weeks.

Gaps and stop-loss orders

Gaps can cause stop-loss orders to be filled far from the intended price because a stop becomes a market order once the price crosses it:
* Long-position example: buy at $50, stop at $45; an overnight negative event opens at $38 → stop is filled at next available price (~$38), creating larger loss.
* Short-position example: short at $20, stop at $22; an overnight positive event opens at $25 → forced exit at $25, increasing loss.

Risk-reduction tactics:
* Avoid initiating or holding significant positions through earnings and major news.
* Reduce position size during expected volatility.
* Use limit orders or options strategies if available to control execution price exposure.

Trading strategies involving gaps

  • Playing the gap (entering after a gap)
  • Gap-and-go (buy the gap up): enter long early in the session when a gap up occurs above resistance and volume is strong; stop often placed below the gap bar’s low.
  • Sell the gap (short gap down): mirror strategy for gap downs.
  • Fading the gap (contrarian approach)
  • Trade opposite the gap on the premise many gaps get filled. Place stops beyond the gap bar high (for fading gap ups) or below the gap bar low (for gap downs). Profit targets often near the prior day’s close.
  • Using gaps as an investing signal
  • Breakaway and runaway gaps can indicate continuation and offer entry points for longer-term trades, often managed with trailing stops until an exhaustion gap or reversal occurs.

Volume and confirmation

  • Higher-than-average volume on a gap strengthens the signal that price will continue in the gap direction (especially for breakaway gaps).
  • Exhaustion gaps often occur with lower volume relative to recent moves.

Example (illustrative)

A large gap after an earnings surprise can wipe out significant value overnight. For instance, a stock closing near $217 opened the next session around $175 after a worse-than-expected earnings report—an almost 20% gap down—demonstrating both the market impact of news and the potential limitations of stop-losses in fast moves.

How to reduce gap risk

  • Avoid holding or initiating large positions right before earnings or other material announcements.
  • Limit position sizes during periods when gaps are more likely.
  • Consider hedging with options or using limit orders where appropriate.
  • Use clear stop placement and be aware that stops can still be subject to slippage on gaps.

Quick FAQs

  • What is a “gap and go” strategy?
  • Buying into a gap up early in the session, aiming to ride continued momentum; stop placed below the gap.
  • Can you predict a gap up?
  • No method guarantees a gap up. Positive surprises (earnings beats, takeover rumors, product approvals) make gap ups more likely but are not certain.

Gaps are a visible and actionable feature of price charts. Understanding the type of gap, volume behind it, and how it fits into the broader trend helps traders and investors interpret their significance and manage the risks associated with sudden overnight price moves.