Price Gaps
A gap is a break between prices where no trading has taken place. Gaps can be created by factors such as a certain news release or an earnings announcement. Gaps are significant when followed by an increase in volume.
There are 4 types of gaps:
1) Common Gaps
- This gap commonly occurs.
- They’re rapidly closed (prices fill the gap within a few days)
- Usually occurs in quiet trendless markets.
- Least useful of the gaps
2) Breakaway Gap (good sign of a new trend)
- Usually occurs at the end of an important price pattern, such as after a non-trending consolidation pattern.
- Usually signals the beginning of a significant market move, such as a potential change in a trend.
- This gap is known as breakaway because the gap moves the price out of a non-trending consolidation pattern into a trending pattern.
- Can remain open for weeks, or months, even years. Many are left unfilled, but sometimes prices may fill a portion of the gap.
- Usually occurs on heavy volume. The heavier the volume, the less likely the gap is to be filled and the more likely the trend will continue.
- Prices should not fall below gaps during an uptrend. A close below an upward gap is a sign of weakness in all cases.
3) Runaway Gap also known as a measuring or continuation gap
- Occurs in the midst of a powerful trend, which continues to reach new highs or new lows without filling the gap.
- In uptrend, a runaway gap is a sign of market strength. In a downtrend, it is a sign of weakness. These gaps signal a continuation of the preceding trend and can mark good entry points.
- Runaway gap is also known as the measuring gap because it usually occurs near the middle of a trend. Since this is a good sign that the current trend will continue, you can measure the distance the trend has already traveled and double it to determine when it is time to begin taking profits.
- Volume is not as important in a runaway gap as it is for a breakaway gap, but it should still be consistent.
- Prices should reach new highs or new lows within a few days. If it doesn’t, the gap might actually be an exhaustion gap.
4) Exhaustion Gap (appears at the end of trends- suggests a reversal might occur)
- Towards the end of an uptrend, price leaps up and forms an exhaustion gap but reverses within a couple days, closing the gap.
- Prices closing below the gap confirm that it is an exhaustion gap, signaling the trend is reversing.
- The gap usually occurs on high volume.
- Be careful 鈥?these gaps might look like runaway, or continuation, gaps in the beginning. If prices do not set new highs or new lows a few days after the gap, then it is more likely an exhaustion gap.
Island Reversal Pattern
- Island reversal gap pattern. This is when after exhaustion gap occurs, there is a period of flat trading, followed by another gap forms in the opposite direction.
- This pattern is a strong signal that identifies the top or bottom of a trend, indicating a reversal.
- The size of the reversal depends where the island forms. If it occurs near the beginning of a trend, then the size is less significant.
