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Gap-Up and Gap-Down in Stock Market Trading
The prices of stocks in the stock market are ever fluctuating. This rise and fall of prices are known as the gap-up and gap-down phenomenon. These gaps are a result of increasing or decreasing stock prices because of no trading activity. This can occur due to various factors. Moreover, there are different types of gaps.
Published on 07 February 2023
Read all about this below.
Understanding Gap-Ups And Gap-Downs
The price levels of two consecutive days are consistently correlated with gap ups and gap downs. Full gap up and gap down is considered extremely crucial from the decision-making perspective.
A full gap-up happens whenever the opening price of the stocks on the next day is higher than the last day’s high price. Meanwhile, full gap down stocks takes place when the stock’s opening price is lower than the low price of the last day.
Likewise, a partial gap-up takes place when the stock’s opening price goes up and above the last day’s close but not above the high price of the last day. Partial gap-down stocks take place when the price today is below the previous day’s closing price but not below the previous day’s low.
These four types of gaps are the fundamentals of the gap up and gap down strategy, their analysis, clarification, and their application to share market trading.
Whether you prefer trading in NSE or BSE, you’ll get benefits in terms of short-term profit gains with gap-ups. Gap-up opening stocks indeed give you the opportunity to earn well.
Today, NSE has become the hotspot of day trading operations, and you can win big by having a proper grip on gap analysis and knowing how to trade in gap up and gap down.
What is Gap-Up And Gap-Down in Stock Market Trading?
When the price of stock changes between the closing and the opening of two consecutive trading days, you call it a gap. These gaps occur when there are any positive or negative announcements by the company. They can also be seen if there is a change in the trade analyst’s view or when there is visible buying and selling pressure among traders.
Additionally, gaps can either be full or partial. So, essentially there are four categorisations of gaps:
- Full gap-up:This happens when the price of a stock opens at a higher note compared to the previous trading day.
- Full gap-down:This is when the price of a stock opens at a lower note than the previous trading day.
- Partial gap-up:A partial gap-up is caused by an increase in the opening price of a stock. However, the price is not more than the previous trading day’s price in a partial gap-up.
- Partial gap–down: In a partial gap-down, the price of a stock is lower than the opening price, but it is not below the previous trading day’s price.
What are the Different Types of Gaps?
Some common types of gaps include the continuation gap, the breakaway gap, the common gap, and the exhaustion gap. Let’s understand each of these, so you can effectively use the gap up and gap down strategy:
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Breakaway gaps
A breakaway gap takes place when the price breaks out of a long-standing trading range through a gap. There are various types of chart patterns through which you can spot a breakaway gap. Such patterns include wedges, descending or ascending triangle chart patterns, etc.
When the gap is confirmed, you can initiate intraday or swing trades. These gaps could be identified via the sharp surge in the trading volume.
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Exhaustion gaps
This gap usually occurs when trending periods take place. The final gaps in this trend’s direction are made by the pricing, which then reverses.
They are determined by a large price and high volume difference between yesterday’s close and the new opening price. You can easily mistake them for runaway gaps if you fail to observe the astonishingly high volume.
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Common gap
If the stock market opens sideways and there’s a very little or small gap between the price of yesterday’s close and today’s open, such as -0.44% to +0.44%, you can refer to it as a common gap.
When compared to other gaps, this one fills out quickly. Common gaps are also referred to as ‘trading gaps’ or ‘area gaps.’ Plus, these gaps are usually portrayed by typical day-to-day trading volume. However, the downside is that you won’t get any good trading opportunities with these gaps.
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Continuation gap
The continuation gaps occur midway through the market trends. When there’s an uptrend, the upward gap resembles continuation and also exhibits that the extra buyers have come into the stock market to push the prices higher. However, these gaps aren’t that big in terms of size to confirm sustainability.
How to Use the Gap Up and Gap Down Strategy?
Here are a few things to keep in mind when using the gap up and gap down strategy:
- Before you trade in a gap, make sure to analyse the trend.
- Gaps can highlight the beginning or end of a trend, which makes them a crucial aspect of technical analysis. Every type of gap can have a unique indication and interpretation. This can affect your trading strategy differently.
- When the stock of a company starts to fill a gap, there is no stopping. This usually happens because there is no resistance or support from the market. Gaps are representative of an area without resistance or support. So, you need to devise a strategy accordingly.
- It can be confusing to identify a gap. So, make sure you identify the gap correctly. For instance, the breakaway and exhaustion gap may look the same many times. But you can look at the volume to differentiate between the two. For instance, the breakaway gap will have a high volume, and the exhaustion gap will have a low volume.
- It may be tempting to get into a gap the moment you see a trend. However, this can be deceptive in some cases. Many gaps are very short-lived. It may help to wait a bit and study the gap more efficiently before you start trading in it. Trade a gap only if you see a confirmation.
Gap Strategies In The Indian Stock Market
On weekdays, the trading market in India opens once the pre-opening session ends. Public holidays stand as an exception here. It’s true that there’s high volatility during the first few minutes.
During that time, buyers and sellers follow their intellect and understanding of the trend to match prices. If you’re a trader who wants to avoid risk at all costs, you must start trading after a careful and thorough analysis of the stock market course.
It’s best to have a proper gap-up and gap-down strategy in mind before investing a large chunk of money. Failing to do so can result in the generation of substantial losses. If you’re a seasoned trader and investor, you can use your market perception to make a quick profit.
Things To Note When Gap-Trading
- Whenever a stock starts filling out a gap, it won’t stop, as there will be minimal or no resistance or support in the stock market.
- The exhaustion and continuation gaps are unique and different, making it crucial for the trader to ensure which gap they follow.
- Keep a note of the stocks’ volume, as low volume takes place during the exhaustion gap, and high volume takes place during a breakaway gap.
- Solo traders are most likely the ones making decisions with the market flow. On the other hand, institutional traders take the high road.
When trading in gap up and gap down, it’s crucial to study, assess, and analyze the market trends. Once you comprehend the working of the gap, it becomes simpler to drive high returns.
Conclusion
Gap up and gap down stocks are not as tough to spot as you may think. However, it may be better to be prudent than irrational. If you are a risk-averse trader, try to begin your trade based on stock market direction and not mere perception. Also, keep in mind that when you trade in the short-term, you must concentrate on making small profits consistently over time.
