Does the Gap Tend to Close?

It is apparent to everybody that there often are significant price leaps at the opening of markets on Monday compared the closing price on Friday. Such leaps can be noticed not only after the weekend but also during working days.

Such leaps are also called gaps.

In this article, we will examine what a gap is. When does it appear? How is it formed? What is the gap's closing? You can find answers to these and many other questions in our article.

Many authors write about gaps (price gaps, spaces, or windows), such as: John J. Murphy in his book “Technical Analysis of Futures Markets: Theory and Practice”, Jack D. Schwager in the book «Technical Analysis. Full Course.”, Cornelius Luca in the book “Technical Analysis Applications in the Global Currency Markets”, Steve Nison in the book “Japanese Candlesticks”, Thomas DeMark “A New Science of Technical Analysis”, and others.

The common feature of these descriptions is that a gap (a price gap, a space, or a window) means a price severance between two consequent candlesticks.

In our research, we define a gap as the difference between the opening market price on the current day and the closing market price on the preceding day.

And if there is a great difference between the closing and opening prices, it is followed by a price leap. We can clearly see this in the following image:

Types of gaps and reasons of their appearance:

1. The Inflation Gap, or a breakdown gap, is usually formed by unexpected news of varying importance which creates bullish or bearish sentiments at the moment of their release.
2. The Continuation Gap, or a “runaway” gap, is caused by a rapid price movement.
3. The Trading gap, or an ordinary gap, occurs when the instrument is traded as usual but a small gap occurs at the middle or low trade volume.
4. The Depletion Gap occurs near the end of a big movement. It means that almost everybody who was interested in trading this instrument has already opened positions and the interest has depleted. In this regard, the price can form a big gap at a small trade volume. A big gap with at a low volume indicates that the number of those who want and can trade has significantly decreased.

It is commonly believed that gaps tend to close.

The gap’s closing is a return of the price chart to the initial level after a certain period of time.  

Among traders, it has been argued that all gaps close without exceptions. So, the gap formed with a price discrepancy will be “filled” with the price. And if so, any such price gap can be used in practice and make a profit. 

However, it is important to understand that the gap’s closing may occur both imediatelly as well as with a passage of time. Thus, some gaps in quotes remain open for weeks, months, and even years.

Statistically, a gap closes in 60-70% of cases of its appearance.

Let us check if this is true.

Method of event determination 

We will estimate the gap on charts in the following way (based on the example of the upward gap):

• We search for the price gap at the opening of a new trading day:

Open1 > Close2

• We estimate the value of the price gap, L, in the following way:

L = |Open1 - Close2|

• The minimum value of the gap, L, meets k% of the closing price of the preceding day:

L >= k % * Close2

• If all conditions are met, then we have a gap.

The above-mentioned mechanism helps to spot the upward formation of a gap. For the downward gap, the situation is the reverse.

The k parameter determines the gap’s minimum value in % of the closing price of the preceding trading day.

In our research, the k parameter is assigned to values: 0.1% (a small gap); 0.2% (a middle gap); 0.3% (a big gap). With growth of the k parameters, the price gap increases.

After the gap’s determination, we check when it closes:

• On the 1^st day (the day of gap’s formation);
• On the 2^nd day;
• On the 3^rd day;
• On the 4^th day;
• On the 5^th day.

If the formed gap did not close within 5 days, we refer to it as unclosed. 

Analysis of the results

The results are shown in the following tables.

The number of gaps and the share of gaps in the sample of market segments:

It should be noted that gaps often appear on the stock charts and rarely on the charts of currency pairs.

With an increase of the price gap, the number of gaps and respectively the share of gaps decrease.

Let us see the share of closed gaps.

The number and share of closed gaps:

As we can infer, with an increase of the price gap, the probability of its closing slightly decreases.

The overall share of closed gaps and the share of closed gaps by day:

Regardless of the value of price gaps, the proportion of closed gaps is roughly the same for each of the 5 days following the day of the gap’s formation.

On the day of formation, the gap closes: in 52 % of cases for a small price gap, in 49 % of cases for a middle gap, and in 46% of cases for a big gap.

Within the next days, the probability of the gap’s closing significantly decreases.

If we examine gaps only for weekend days (opening of Monday – closing of Friday), we can see the following results (weekend gaps are highlighted with color):

The numbers of gaps and, respectively, closed gaps significantly decrease. However, the probability of the Gap’s closing has changed only slightly, by 1 %.

So, we can draw the following conclusions.

The probability of the gap’s closing with a small gap is 67%, with a middle gap is 65%, and with a big gap is 63%.

Such results confirm the conventional belief about gap closing. 

Around half of gaps are closed on the day of their formation.

Within the following days, the probability of the gap’s closing significantly decreases.

Detailed results are shown in the Appendix:

XLSX (0.06 MB)Application to the article 'Does the Gap Tend to Close'.xlsx