In trading, a gap refers to a significant difference in price between the closing price of a financial instrument and the opening price of the next trading session. It occurs when there is no trading activity or price movement between those two points, creating a gap on a price chart.
Gaps can occur for various reasons, such as news announcements, economic reports, earnings releases, or other market events that happen outside normal trading hours. When new information is released during these periods, it can cause a sudden shift in market sentiment, resulting in a gap when the market reopens.
There are three main types of gaps in trading:
- Common Gap: This is the most frequently occurring gap and usually has less significance. It occurs in normal market conditions and tends to get filled, meaning that the price eventually returns to the level of the gap.
- Breakaway Gap: This gap occurs when there is a significant change in sentiment or market direction. It often happens after a period of consolidation or when a significant level of support or resistance is broken. Breakaway gaps can signal the start of a new trend or a strong continuation of an existing trend.
- Exhaustion Gap: This type of gap often occurs near the end of a trend or a significant price move. It represents a final surge of buying or selling pressure before a reversal or a temporary pullback occurs.
Traders analyze gaps to understand market behavior, sentiment, and potential trading opportunities. Gap trading strategies involve entering positions based on the assumption that the price will move to fill the gap, either partially or completely. However, it’s important to note that gaps may not always get filled, and trading gaps can be risky, so appropriate risk management techniques should always be employed.
Overall, gaps in trading represent significant shifts in price levels and can provide insights into market sentiment and potential trading opportunities. Traders use various techniques and strategies to analyze and trade gaps, considering factors such as the type of gap and overall market conditions.