Gapping

Gapping describes the situation when a stock value or an asset value goes up or down in comparison with the previous day's price without any trading in the stock market. A gap is defined as a break between values on the price chart. They may appear when new information comes from different sources but stock markets are closed and the quiotes aren’t updated. 

Another meaning of gapping is a change in rates at which banks offer loans. The dynamic gap analyzes how assets and liabilities become different over a period of time. 

Gapping Explained

It can appear in non-trading hours between trading sessions. The process of buying and selling currencies takes place every day but gaps between the closing time (before the weekend) and opening time of the market still may occur. 

There are 2 kinds of gapping:

• partial (appears when the price at which a security first trades on a new day is above or below than the value at the end of the previous trading session but within its highest and lowest prices);
• full (appears when the opening price is beyond the presented prices of the previous day).

Main Types

There are 4 main types of gaps. They are distinguished by their size, where they appear within the overall trend of the asset. Common gaps tend to be partial as there is no significant move on the stock market, while other gaps are usually full.

Common Gaps. They often occur in an illiquid market because of the lack of significant supply and demand. This type of a gap has no value for predicting price movements as the opening price hardly differs from the closing price.

Breakaway Gaps. A breakaway gap appears when the value goes above a significant resistance area or below a significant support area on the gap. It is characterized by increasing trading volume and demonstrates that the price movement is likely to continue for a long time. 

Runaway Gaps. It appears in the middle of a strong trend. Due to this we can approximately estimate the duration of the current trend. These gaps are usually large and the value moves in the direction of the gap. 

Exhaustion Gaps. It is very similar to the breakaway gap. It also occurs in an existing trend and is accompanied by large volumes. However, the reason why they are formed is that traders are trying to buy or sell stocks at the end of the trend as they regret that they haven’t done it earlier. This gap symbolizes the end of the current trend. There is typically a reversal in a couple of weeks.

What is a Stop Loss Order

Stop loss order is an order that automatically closes a trade at a given price. It is used as a protective mechanism for the trading capital when there is gapping. 

For instance, a trader invests in a stock valued at $30 at the end of the trading session and his stop-loss order is fixed at $25. After that the organization makes an announcement regarding their profit and the price of the stock changes. When the trading action begins, it opens at $20. This order is now a market order as the value of the stock is below $25. 

People who buy or sell stocks can influence the materialization of gapping and prevent it by not taking any actions right before companies announce their profits and before other economic indicators. 

Gap Trading

Many traders take advantage of analyzing gaps as they can understand the type of the gap, estimate income level and minimize losses. Some of them have their own gap trading techniques. 

Buying the Gap (Up). The amount of an asset may be taken during a trading session on a gap stock. In this case an order is typically placed beneath the low of the gap bar. An investor finds a stock with a gap in the pre-market before the market reopens. After it opens, he confirms the upward movement of the price and buys it. When an investor notices that there is a downward trend, he gets out of the trade and gets his profit. 

Selling the Gap (Down). This strategy has almost the same points as the previous one but here a trader invests in shares after there is a gap down. 

Fading the Gap. When we use this strategy, we rely on the fact that the gaps are usually filled in the market. An investor should place an order above the gap bar's high, when there is an upward trend, and below the gap bar's low, when there is a downward trend. 

Signals for Investors. Breakaway and runaway gaps indicate traders that they can make use of an upward trend and turn it into a profit. Thus, they can enter a position and close it when there is an exhaustion gap.