T2W Trading Community

Gaps are a common occurance in the markets. Everyday there is always at least one stock that has gapped up or down when the market opens. Why? As long there is some event happening somewhere between the market close of the previous day to the opening of today, there will be gaps. Even if the markets eventually move little by little toward the inevitable 24-hour format, there will always be gaps. After all, somewhere around the world, there is some event happening during the weekends as well. Plus, there is always an excited group of investors who making a big deal out of something or even for no reason unknown to the rest of us. So, gaps are a fact of life and there is no avoiding them. The best thing to do is take it in your stride and learn how to profit from them.

There are three different types of gaps:

Breakaway, Runaway and Exhaustion gaps.

Each of these gaps appear at a different cycles of the markets.

Breakaway gaps occur when a stock has been in a consolidation stage; instead of a normal market-session move, it breaks out with an opening gap. Normally, these gap in the same direction before to the consolidation stage. There is one caveat: when the breakout happens, it can be in either direction. This gap is trickier than the others because the intent of direction is unclear.

In the chart example above, the market was going through a correction. When it finally finished consolidating (a symmetrical triangle pattern), it broke out with a gap to the upside to end the correction period.

As for Runaway gaps appear when the stock has been trending for some time. Instead of a normal move up during market hours, they open with a gap in continuation of the dominant trend. It shows there is more interest in the stock, possibly by some positive news to further boost the investors’ eagerness to own it. Runaway gaps are also called Measuring gaps because they are often used as a centering point of measurement from the beginning of the trend to the gap, then from the other side of the gap to measure the next likely level where it would reach.

The chart below shows the prevailing trend, moving steadily upward. Along comes the opening gap, pushing in the same direction higher, not even a moment’s pause or pullback until much later in the trend.

Below is the example of how a Runaway gap is also used as a Measuring tool. When the gap has been identified, the measurement is taken from the beginning of the trend (61.98) up to the bottom of the gap (87.08). From that distance, it is used to measure how far the prices will likely to continue. So the measured target starts at the upper part of the gap (102.64) to the expected level above it. In this example, the target was 130.27. This is a very powerful and easy-to-apply concept which can be used to find profitable trades.