Breakaway Gaps (BGUs)
Master explosive gap-up moves out of bases and learn to identify, enter, and manage breakaway gap trades for multi-week momentum opportunities
Breakaway gaps, also known as “BGUs” (buyable gap-ups), are explosive moves out of a base, often triggered by a catalyst like earnings, FDA approvals, or major announcements. These gaps frequently lead to multi-week moves when executed properly. In this lesson, you’ll learn how to identify, enter, and manage breakaway gap trades while minimizing risk.
Learning Objectives
By the end of this lesson, you will be able to:
- Identify the key characteristics of a breakaway gap
- Understand the importance of bases and catalysts for successful BGUs
- Develop entry strategies for both post-market and regular sessions
- Manage position sizing and liquidity considerations in gap-up scenarios
- Recognize and avoid exhaustion gaps at the end of trends
Understanding Breakaway Gaps (BGUs)
Definition
A breakaway gap is a sudden and significant gap higher in price, typically accompanied by heavy volume, that breaks out of a well-defined base. These gaps often signify the beginning of a strong uptrend.
Key Characteristics
- Explosive Gap Out of a Base: The gap occurs after a period of consolidation or basing, not after an extended rally
- Catalyst-Driven: Usually triggered by earnings reports, product announcements, or regulatory approvals
- Heavy Volume: Significant trading activity in post-market or regular sessions supports the breakout
Why BGUs Work
When a stock gaps higher on a catalyst, it signals a change in sentiment, often attracting buyers who were waiting on the sidelines. This influx of demand can fuel multi-week price moves.
Importance of Bases and Catalysts
Role of Bases
A solid base provides a foundation for the breakout, ensuring that the stock is not overextended before the gap. Without a base, gap-ups are more likely to fail.
Example
Stocks that gap higher out of a weekly base are more likely to sustain their upward momentum compared to those gapping up after several weeks of rallying.
Catalysts
Catalysts like earnings are critical for BGUs. For example, a strong earnings beat can lead to heavy buying in post-market trading.
- Earnings: The most common trigger for BGUs
- Product Announcements: New product launches often drive significant gaps
- Regulatory Approvals: In sectors like biotech, FDA approvals can trigger massive moves
Entry Strategies for Breakaway Gaps
Post-Market and Pre-Market Approach
- Monitor Volume: Look for significant trading volume in the post-market session (e.g., 40-50% of average daily volume)
- Buy in Pieces: Enter a small position in the post-market or pre-market session to reduce risk, then add to it during the regular session if conditions remain favorable
Regular Session Approach
- Lower Timeframe Entry: Wait for a pattern like a bull flag or inside bar on a 5- or 15-minute chart to form after the gap and use that as your entry point
- Day-One High Breakout: An alternative strategy is to buy as the stock clears the high of its first regular trading session after the gap
Managing Risk and Position Sizing
Position Sizing for Thin Stocks
For thinly traded stocks with wide bid-ask spreads, reduce your position size to account for higher volatility. Example: If a $60 stock moves $2 in a 5-minute bar, position sizing should reflect the increased risk.
Stop-Loss Placement
- Initial Stop: Place your stop-loss just below the low of the gap day
- Adjusting Stops: If the stock begins to move favorably, tighten your stop to minimize potential loss or lock in gains
Avoiding Exhaustion Gaps
Definition
Exhaustion gaps occur at the end of extended rallies and often signal the end of a trend rather than the start of one.
Key Differentiators Between BGUs and Exhaustion Gaps
- BGUs: Break out of a base and occur early in a new trend
- Exhaustion Gaps: Occur after several weeks of rallying and are often used by insiders to sell into strength
Example
If a stock has been rallying for 4-6 weeks and gaps higher, it is more likely an exhaustion gap. Avoid these trades as they often reverse quickly.
Reflection
Why is it important to wait for a breakaway gap out of a base instead of chasing gaps in already extended stocks?
Action Items
- Analyze recent breakaway gap examples (e.g., UPST) and compare the volume, base size, and catalyst driving the move
- Practice identifying and trading BGUs in a simulated environment to refine your execution skills
- Create a checklist for trading breakaway gaps, including criteria for entry, position sizing, and stop-loss placement
Conclusion
Breakaway gaps are powerful trading opportunities, especially when they occur out of a solid base and are driven by catalysts. While challenging to execute, they can offer significant rewards when approached with discipline and a clear strategy.
The key to successful BGUs lies in recognizing the right conditions—strong bases, heavy volume, and impactful catalysts—while avoiding exhaustion gaps. Manage your risk carefully and refine your execution over time to capitalize on these dynamic moves.