Gap-up and Gap-down: Stock Market Trading | Motilal Oswal

What does Gap-up and Gap-down state in Market?

A gap is essentially a change in prices levels between the close and the open of two consecutive days. In simpler terms, “gapping” is said to occur in the stock markets when the price of a certain stock, or any other asset for that matter, opens either above, or below, the close of the previous day, assuming there is no trading conducted in between that time. Therefore, a gap represents an area of discontinuity in the ptice chart of any given security. Gaps may show up when headlines result in market fundamentals to fluctuate on a rapid basis when the markets are closed. For example, this could happen with an earnings call in the after-hours of the stock market’s function. Before you understand more about gap up stocks (which is actually more of a process) and gap down stocks, you should be aware of gapping and its aspects in general. 

Gap analysis requires confirmation that is only available after the price movement actually manifests itself. For example, there are different types of gaps like common gap, breakaway gap, continuation gap and exhaustion gap, but all these gaps are fully clear from a decision point of view only after the price impact is visible on these stocks.

Before getting into gap and gap down strategy, let us first understand more on gapping and why do stocks gap or gap down. Let us also understand about partial gaps and full gaps and then look at how to trade gaps successfully.

An Explanation on Gapping

Knowing about some “gap basics” may help to understand the concept of gapping better and lead to some effective use of this in the stock markets where you trade. Here are some important takeaways on the subject of gaps (mainly pertaining to stocks and the stock markets): 

  • Gap up opening stocks are those that would open in the next trading session at a high price (as they had closed at a high price in the previous session of trading or due to some factors that have led to the raise between trading sessions). 
  • In the case of a gap down stock, the stock would open at a low price corresponding to the previous trading session’s price. 
  • A “full gap” is said to occur when the price of a stock is fully “open” outside of the previous session’s stock price. 
  • As you may have gauged, any kind of gap has implications for subsequent trading sessions and gives signals to traders. 
  • Sometimes, common gaps may be too small and regular to give any real insight into the analysis of trades effectively. 


Understanding gap-ups and gap-downs
 

Gap ups and gap downs are always with reference to two consecutive day’s price levels. Very important from a decision point of view are full gap ups and full gap downs.
A full gap up occurs when the next day opening price is higher than the high price of the previous day. Check the chart below, where the green arrow depicts the gap up point.

A full gap-down occurs when the opening price of the stock is lower than the previous day’s low price. In the chart below, the full gap up is depicted by the green arrow and the full gap down is depicted by the red arrow.

Similarly, a partial gap-up occurs when the opening price is above the previous day’s close but not above the previous day’s high price. On the gap-down front, it is when today’s price is below the closing price of yesterday but not below the low of yesterday. These four gaps are at the core of gap up and gap down analysis, their interpretation and their application to actual stock market trading

Whether you trade in the BSE or NSE, you will find that gap ups help in short-term profit gains. You can really earn with gap up opening stocks. NSE today is a hotbed of day trading activity and getting a grip on gap analysis may help you win big. 



Breakaway gaps and Exhaustion gaps
 

Actually, there are 4 types of gaps that are critical from an analytical point of view. It is essential to understand these four categories so that the gap events can actually be converted into strategies.

Breakaway gaps are the gaps that occur at the end of the share’s price pattern. Break away either indicate a break-up or a break-down. Either ways, they indicate a new trend or the beginning of a new direction.

Exhaustion gap represents the opposite end of the spectrum compared to the breakaway gap. Exhaustion gap represents the final leg of a price pattern and is an indicator of a final attempt to reach the new high or lows in pricing. This is used to indicate reversals of patterns.

Common gap represents the area of price gap and actually tells you the square area within which you can actually apply your strategy.

Lastly, there is the Continuation gap which occurs in the middle of a stock’s price pattern and indicates a common belief of a group of buyers or sellers on where the stock is headed. This could be either an affirmation of an uptrend or an affirmation of a downtrend.

 

Apply Gaps practically in the Indian context
 

Gaps are a critical component of technical analysis as they either emphasize the beginning of a trend, conclusion of a trend or the perpetuation of a trend. Either ways, this is an important input for your trading decision. There are 4 basic approaches that you must focus on when it comes to applying gaps from a strategy point of view.
 

  • Gaps are normally deep pits or high ceilings and these gaps have to be filled. Gap indicates an area where there is no support or resistance. Once a stock starts to fill a gap, it will not stop, and you need to calibrate your strategy accordingly.
  • Each gap has its own interpretation and hence has its own strategy attached to it. For example, the continuation gap shows perpetuation of a trend while the exhaustion gap shows the fag end of a trend.
  • How do you differentiate between a breakaway gap and an exhaustion gap? Both tend to look quite similar at times. The answer is to look at volumes. Normally, high volume occurs in a breakaway gap, and low volume occurs in an exhaustion gap.
  • Don’t jump into any gap the moment you spot the trend. Many gaps can be misleading and some of them can be too ephemeral. Wait for the gap to manifest some degree of confirmation before trading it. When you see a gap up opening stock, it's not a good idea to leap to trade in it before you do some research first. 

 

Get Your Gap Information Right

When you are a regular trader, you can make use of gap analysis and view the gap up stocks today to make your trades effective. Gaps basically come into the picture due to any underlying technical and fundamental factors. For instance, in the case of the earnings of any company, earnings may be higher than expected and stock prices may go up by the time the next day’s trading starts. This means that the company’s stock price opened higher (gap up) than it closed in the previous day’s session. Therefore, there is a gap in the stock price. Particularly in forex markets, it isn’t an uncommon occurrence when you see a report that generates a lot of buzz which widens the spread of bid and ask to a certain point when a large gap is witnessed. This does happen with stocks too. 

 

Gap analysis is actually quite simple or, at least, not as complex as it is made out to be. Trading short term is all about making small profits consistently. That is exactly what these gaps can help you do!
 

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