Why stock gaps occur and how to trade them.

What is a stock gap?

A stock gap occurs when a stock’s price shifts noticeably, either up or down, during after-hours trading when the general market is closed. This leads to the stock opening at a different price than its closing price from the previous trading day. Understanding stock gaps is vital for traders as they can signal significant market events or sentiments about a stock.

Gap-Up: This happens when a stock opens at a higher price than its closing price on the previous trading day. Gap-ups often indicate positive investor sentiment or reactions to favorable news, such as strong earnings reports, positive industry developments, or favorable macroeconomic factors.

Gap-Down: In contrast, a gap-down occurs when a stock opens at a lower price than it closed the previous day. This typically reflects negative investor sentiment and can be triggered by events like disappointing earnings, regulatory challenges, or broader market downturns.

Understanding the Reasons Behind Gaps

Stock gaps can result from a variety of factors, including but not limited to:

• Earnings reports and financial updates
• Mergers and acquisitions
• Changes in leadership or strategic direction
• Regulatory changes or legal issues
• Economic indicators and macroeconomic shifts
• Sector-specific news

Monitoring Stock Gaps

Many websites, like barchart, offer pre-market listings of stocks with the largest gap-ups or gap-downs. These resources are invaluable for traders looking to identify potential trading opportunities or risks. By monitoring these lists, traders can get an early indication of market trends and sentiments for the day ahead.

Do stock gaps always get filled?

Gap ‘filling’ refers to the stock price returning to its level prior to the gap up or down. Whether or not a stock gap will fill depends on various factors, making it an important aspect for traders to understand.

Types of Gaps and Their Potential to Fill:

1. Common Gaps: These often occur in normal market conditions and are likely to fill quickly, as they don’t typically represent significant market shifts.
2. Breakaway Gaps: Occurring at the start of a new trend, these gaps are less likely to fill soon, as they indicate a stronger market movement.
3. Runaway Gaps: These are associated with a trend’s midpoint and suggest a strong market sentiment, making them less likely to fill in the short term.
4. Exhaustion Gaps: These appear near the end of a trend and are more likely to fill as they signal the trend’s conclusion.

How do I trade stock gaps?

All gap ups are NOT created equal and it is important that you know what separates a stock gap with potential vs one that is likely to fade. One of the biggest factors for gap ups is the amount of volume behind the move. If the gap up is on light volume, this really doesn’t tell us much.

However, if it occurs on BIG volume, this is an indication of new institutional interest. When there is big volume on a gap up, there is almost always a change in the story of the stock. There has been a fundamental change or turnaround in the company and therefore the technicals are going to change as well as the big institutions get involved.

This is a sign of demand, one of the key components of the CANSLIM investing methodology.

Another important factor in determining the quality of a gap-up is the closing range of the candle. You want to see a gap-up ideally close in the upper 50% of its daily trading range.

Frequently Asked Questions