What Is A Stock Gap?
Why stock gaps occur and how to trade them.
Understanding how to trade gap ups or downs is a very powerful trading skill. Often the biggest gainers of the day are stocks that gap up, but what is a stock gap in technical analysis? In this post, we will quickly explain what a stock gap is, why stock gaps occur, and how to properly trade them.
Table of Contents
What is a stock gap?
When a stock moves either up or down in after-hours trading, when the general market is closed, it results in the stock opening at a different price than what it closed at the prior trading day.
A gap-up is when the stock opens at a higher price than what it closed at the previous trading day.
A gap-down is when the stock opens at a lower price than what it closed at the previous day.
A ton of sites like BarChart.com will have lists of the stocks pre-market with the largest gap-ups or gap-downs.
Why do stocks gap up?
The most common reason for stocks that are gapping up or down is a news catalyst.
When news is released during pre-market or after-hours it generally results in the stock opening at a different price than it closed the prior trading day.
Other common examples that cause a stock to gap up or down are analyst upgrades or downgrades, press releases, trial results, or quarterly earnings releases.
Stocks don’t always have a major catalyst for gapping up or down, it could simply be due to supply and demand. At times, you will see stocks gap up on big volume simply because institutions have decided to pile in and position themselves, with no obvious catalyst.
Do stock gaps always get filled?
Filling a gap means that the price of the stock has retraced back to the levels it was at before the gap up/down.
There are multiple types of gaps. By watching price action, you can get an idea if the gap will continue to go in the same direction or come back and fill the gap.
How do I trade stock gaps?
One of the main types of setups TraderLion Private Access focuses on are gap ups and what to look for when they occur.
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.
- Big Volume
- Closes in upper 50% of daily candle
- Opens at new highs or above prior resistance
- General Market Uptrend
- Light Volume
- No Catalyst
- Closes in lower 50% of daily candle
- Opens below prior resistance
- General Market Downtrend