One of the common terms you must have in markets quite often is a gap up or a gap down. Gaps are the space between the open and the closing prices of two consecutive days and such gaps normally get filled. Hence it is an important indicator to the trader in identifying the trading opportunities on the stock. To be precise, a gap is essentially a change in prices levels between the close and the open of two consecutive days. Here we are referring to two consecutive trading days. Gap analysis is retrospective in nature as it 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 evident only after the price impact is visible on these stocks.
Gap ups and gap downs are with reference to two consecutive day’s price levels. It focuses more on prices and does not look at volumes. Let us look at two such very specific types of gaps. For example, 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.
A slight variation of the full gap is the partial gap. 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. This is in contrast to the full gap up where the next day’s open is above the high price of the previous day too. These four gaps (full gap-up, full gap-down, partial gap-up and partial gap-down) are at the core of gap up and gap down analysis and their interpretation in the context of stock market trading.
It is important to grasp the four categories of gaps so that these gap events can be converted into trading strategies.
Gaps emphasize one of the three; the beginning of a trend, conclusion of a trend or the perpetuation of a trend. Here is how you can actually apply the analysis of gaps to your trading strategy in the stock markets. Remember, gaps are retrospective and therefore work quite reliably.
Gap analysis is quite simple and can be handled with some basic charting knowledge. But the real challenge lies in getting confirmation that it is actually the gap that you believe.
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