Have you considered trading gaps in one-day patterns and chart formations? If you haven’t, you are missing out in trading opportunities that, if applied correctly, can be extremely profitable. Although there are several strategies to trade one-day patterns and chart formations, this article will focus on the different types of gaps and how to profit from them.
As we discussed above, there are different types of gaps. Gaps occur after the market closes and before it reopens. A gap will show in your chart with the low price at the opening of the market is higher than the high price when the market closed the day before indicating a possible uptrend or, vice versa, the high price at opening being lower than the low price at market closing thus indicating a possible downtrend. These gaps can be caused by overnight economic news, world events, or just a change of market sentiment. The bigger the gap, the stronger the possibility of a trend developing. Many traders use gaps as entry points, stop levels, or as a measurement of market strength or weakness.
Types of Gaps
Common: Common gaps happen for no particular reason due to market indifference to a specific script or commodity. These gaps are usually small when compared to gaps caused by major events and should be avoided.
Breakaway: The market often has strong levels of support and resistance. As a matter of fact, a script is in a consolidation stage much time while traders decide in which direction it will move. Seasonal trading is a good example of a gap that may develop. For example, a trading channel can develop through the month of December for the holidays and come to an end in January, after the holidays, when a gap may develop indicating more market activity and a new trend.
Exhaustion: This occurs after strong script moves either upwards or downwards. As the uptrend or downtrend comes to an end and the market sentiment shifts, a gap may develop indicating a reversal of the trend. Exhaustion gaps usually occur as traders decide to take profits and exit their positions effectively exhausting the trend and triggering a reversal.
Runaway: These are the opposite of the exhaustion gap. The runaway gap is essentially the confirmation of a developing trend. This can’t be confirmed until subsequent price action confirms that a new trend indeed started and the price continues to move in that direction thus the runaway denomination.
By knowing the different market conditions that may cause gaps, you can determine whether to enter a trade and profit from it.
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