Gap-up & Gap-down Strategy - Types & How to Use | Espresso

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.

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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:

  • Breakaway gaps

A breakaway gap can either reflect a break-up or a break-down. These can be generally seen at the end of the share’s price pattern. They are spotted when there is a new trend or the beginning of one.

  • Exhaustion gaps

The exhaustion gap is seen at the end of the share’s price pattern and is indicative of the final attempt to reach the new high or low in pricing. It represents the opposite side of the spectrum, unlike the breakaway gap. This is why it is often referred to as the opposite of a breakaway gap. 

  • Common gap 

The common gap shows the area within which you can apply your gap up and gap down strategy. This is the area of the price gap. 

  • Continuation gap

The continuation gap is spotted in the middle of a stock’s price pattern. This gap represents the mutual belief of a group of buyers and sellers in the market and indicates where the stock is likely headed. The continuation gap can either mean an uptrend or a downtrend. 

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. 

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. 

Frequently Asked Questions

There are four types of gaps: Continuation gap, Common gap, Exhaustion gaps, and Breakaway gaps.

The movement in the price of a stock between the closing and the opening of two consecutive trading days is known as the gap-up and gap-down phenomenon. 

A discrepancy in the supply and demand of a stock when the market opens the next day due to news or announcements can lead to a gap-up opening. Likewise, when the prices open at a higher note than the previous day, it is a gap-up opening. 

A discrepancy in the supply and demand of a stock when the market opens the next day due to news or announcements can lead to a gap-down opening. Likewise, when the prices open at a lower note than the previous day, it is a gap-down opening. 

A full gap-up results from a higher next day opening price than the previous trading day. Likewise, a full gap-down results from a lower gap-down than the last day's trading.