Gaps in stock market trading appear when there is sharp rise or fall in the price of the stock and when there is no occurrence of the trading activity. The reasons for gap creation can be a positive news release by the company, change in the trade analyst’s view, buying or selling pressure among traders, public announcements of the company’s profit, among others.
Typically, there are two types of gaps in stock trading:
Partial gap -down
Gap-up: When the price of a financial instrument opens higher than the previous day’s price, it is gap-up.
Gap-down: When the price of a financial instrument opens lower than the previous trading day it is gap-down. Gap-downs occur when there is a change in investor sentiments.
Partial gap-up: A partial gap-up in the stock market occurs when a there is a rise in the opening prices but the price is not higher than the previous high price.
Partial gap-down: A partial gap down in stock market occurs when the opening price is below the previous closing price, but not below previous day's low.
Types of gaps in the stock market
Gaps are commonly split into four categories:
Breakaway gaps: These gaps occur at the end of the share’s price pattern and is a signal to a new trend’s beginning.
Exhaustion gap: This gap comes at the final leg of a price pattern and is an indicator of a final attempt to reach the new high or lows in pricing.
Common gap: This is a simple representation which shows the area of the price gap.
Continuation gap: It occurs in the middle of a stock’s price pattern and indicates a common belief of a group of buyers or sellers in the future direction of the stock.
Gap strategies in the stock market
There are many techniques to take advantage of the gaps in the stock market. Some traders will purchase when technical or fundamental reasons like the company’s financial report support a gap on an opening day.
Traders might also invest in highly liquid or non-saleable positions, like a currency that has low-liquidity during the beginning of a price trend, expecting a continued and favorable trend.
There are cases where the traders will shadow the gaps in the opposite direction if the high or low point of the stock is fixed. This often happens due to innate technical analysis.
Gap strategies in the Indian stock market
In India, the trading market opens after the pre-opening session on all weekdays, except on public holidays. The first couple of minutes remain highly volatile, where buyers and sellers try to match prices as per their perceptions of the trend. If the trader is risk-averse, then they should begin their trading after carefully analyzing the course of the stock market. If they fail, they can incur substantial losses. Seasoned investors and traders can make a quick profit depending upon their perception of the market.
Things to note when gap-trading
Once a stock starts to fill a gap, it will not stop as there will be little or no support or resistance in the market.
The continuation gap and exhaustion gap are very different, so the trader has to make sure of the gap he is going to follow.
Take note of the volume of stocks as high volume occurs in a breakaway gap, and low volume occurs in exhaustion gap.
Individual traders are often the ones to decide with the flow of the market, whereas institutional investors will ride the tide to see how it benefits their portfolio.
When trading in gap, it is prudent to study and analyze the trend before trading. Once a trader understands the workings of the gap, it is easier to get high returns.