Stock Analysis
Oct. 25, 202311 min read

What Is a Gap Fill in Stocks? How To Trade Them

[object Object] image

Written by Tim Bohen

A gap fill in stocks refers to a trading scenario where a stock’s price moves to fill a gap that was previously created on a chart. This phenomenon is often used by traders as an opportunity to enter or exit positions. Understanding how to trade gap fills can be a valuable skill in your trading toolkit, offering a systematic approach to capitalize on price movements.

You should read this article because it provides a comprehensive guide on how to trade gap fills in stocks, offering actionable strategies and key rules to maximize your profits.

I’ll answer the following questions:

  • What is a gap fill in stocks?
  • How are gaps in the stock market created?
  • What causes a stock to gap?
  • What does it mean to fill a gap in stocks?
  • What are the different types of stock gaps?
  • How can technical analysis tools aid in gap trading?
  • What are some strategies for trading bullish and bearish gaps?
  • How important is risk management in gap trading?

Let’s get to the content!

What Are Gaps in the Stock Market?

Gaps in the stock market occur when there’s a significant difference between the closing price of a stock on one day and its opening price on the next trading day. In my years of trading and teaching, I’ve found that recognizing gaps can offer traders a strategic edge.

How Is the Price Gap Created?

Price gaps are created due to a variety of factors, such as news events or earnings reports, that can cause a stock’s price to move dramatically. When this happens, the chart shows an empty area where no trading occurred, forming a gap.

What Causes a Stock to Gap?

Stocks can gap due to several factors, including news releases, earnings reports, or changes in market sentiment. Understanding the cause of the gap is crucial for trading it effectively. For instance, an earnings report can result in a gap that may or may not get filled, depending on the company’s performance and Wall Street’s reaction.

What Does It Mean to Fill a Gap in Stocks?

Filling a gap means that the stock price moves back to its original position before the gap occurred. This is often seen as a sign of market correction. Traders use this as an opportunity to either enter or exit positions, depending on their trading strategies and the direction of the trend.

While filling a gap often signals a market correction, it’s crucial to consider the broader market trend. In a down trend, a gap fill might not be as reliable for bullish trades. The stock could fill the gap only to continue its downward trajectory. This is why understanding market trends is essential for effective gap trading. For a deeper understanding of down trends and how they can affect your gap trading, check out this guide on down trends.

Types of Stock Gaps

There are different types of stock gaps, and each has its own trading implications. Knowing the type of gap you’re dealing with can significantly impact your trading strategy.

It’s also useful to study historical contexts where gaps played a significant role. Take the Dot-Com Bubble, for instance. Many tech stocks experienced extreme gaps during this period, both upward and downward. These historical gaps can offer valuable lessons for modern traders. To see how gaps behaved during the Dot-Com era, take a look at this Dot-Com Bubble chart.

Common Gap

Common gaps are usually not associated with any news event and are often filled quickly. They occur frequently but are less significant for traders.

Breakaway Gap

Breakaway gaps occur at the end of a price pattern and signify the beginning of a new trend. These are often seen in charts following significant news events and are less likely to be filled.

Runaway Gap/Continuation Gap

Runaway or continuation gaps occur in the middle of a price pattern and typically signal that a current trend will continue. These gaps are generally not filled and can be a strong indicator for trend direction.

Exhaustion Gap

Exhaustion gaps occur near the end of a price pattern and signal that a trend is about to reverse. These gaps are usually filled quickly, offering traders an opportunity for profit.

Trading Gap Fill Stocks: Gap Trading Strategies

Gap trading strategies can vary depending on the type of gap and the overall market conditions. In my experience, combining gap analysis with other forms of technical analysis can yield the best results.

When trading gaps, it’s beneficial to combine different technical analysis tools. One such tool is the flag pattern, which can often appear after a gap. This pattern can help confirm the strength of the trend following the gap, providing another layer of analysis for your trades. To learn how to incorporate the flag pattern into your gap trading strategies, check out this guide on flag patterns.

Technical Analysis Tools for Gap Trading

Technical analysis tools like support and resistance levels, chart patterns, and trend lines can be invaluable for gap trading. These tools help traders identify potential entry and exit points.

Volume Analysis: Confirming Gap Strength

Volume analysis is crucial in confirming the strength of a gap. High trading volume can indicate a strong gap that is less likely to be filled, while low volume may suggest the opposite.

Strategies for Trading Bullish Gaps

For bullish gaps, buying near the lower end of the gap and selling near the upper end can be profitable. However, always consider the trading volume and other technical indicators to confirm your strategy.

Strategies for Trading Bearish Gaps

In the case of bearish gaps, shorting the stock near the upper end of the gap and covering near the lower end can be a viable strategy. Again, volume and technical indicators should be considered.

Setting Entry and Exit Points in Gap Trading

Setting clear entry and exit points is crucial in gap trading. Use technical indicators to identify these points and always set stop-loss orders to manage risk.

Gap Trading Rules: Key Things to Consider

When trading gaps, there are several key rules to consider. These rules can help you maximize profits while minimizing risk.

Differentiating Between Types of Gaps

Knowing the type of gap you’re dealing with is crucial for your trading strategy. Each type of gap has its own set of trading implications.

Always Consider the Trading Volume

Trading volume is a key indicator of the strength of a gap. Always consider the volume before entering a trade.

Setting Clear Entry and Exit Points

Clear entry and exit points help in effective risk management. Use technical indicators and stop-loss orders to define these points.

Prioritize Risk Management and Stop-Loss Orders

Risk management is crucial in gap trading. Always set stop-loss orders to protect your positions.

What Happens After a Gap is Filled?

After a gap is filled, the stock price often continues to move in the direction of the prevailing trend. However, this is not a hard and fast rule and should be confirmed with other technical indicators.

Key Takeaways

Understanding gaps and how to trade them can offer traders a unique set of opportunities. The key to successful gap trading lies in identifying the type of gap, setting clear entry and exit points, and effective risk management.

There are a ton of ways to build day trading careers… But all of them start with the basics.

Before you even think about becoming profitable, you’ll need to build a solid foundation. That’s what I help my students do every day — scanning the market, outlining trading plans, and answering any questions that come up.

You can check out the NO-COST webinar here for a closer look at how profitable traders go about preparing for the trading day!

Do you use a gap trading strategy? Let me know in the comments!

FAQs

Is Gap Trading Profitable?

Gap trading can be profitable if done correctly. However, it’s essential to use other technical indicators to confirm your trading signals.

Does a Gap Get Filled?

Not all gaps get filled. The likelihood of a gap getting filled depends on various factors, including the type of gap and market conditions.

How Can I Know If a Stock Will Gap Up?

There’s no surefire way to know if a stock will gap up. However, keeping an eye on news events and earnings reports can give you an indication.

What Is Gap Fill in Terms of Trades and Price Action?

Gap fill refers to the situation where trades eventually return to fill a gap in the range of price action. For example, if a stock opens higher than the previous day’s high, prices might eventually drop to fill that gap, which could indicate a reversal in price action.

How Do Analysts View Gap Fills?

Analysts often observe gap fills as areas of interest in the market. They can use information such as liquidity and market capitalization to make educated predictions. This is especially important for investors who rely on these insights to identify potential buyers and sellers.

How Does Exchange and Size Matter in Gap Fills?

The exchange where a stock is listed can impact the likelihood of a gap fill occurring. Companies with a larger market capitalization and size might experience different patterns in gap fills compared to those with smaller value.

What Role Do Buyers and Sellers Play in Gap Fills?

Buyers and sellers are the key market participants that determine whether a gap will be filled. The range in which they are willing to trade often correlates with areas of liquidity, which, in turn, affects the speed and probability of a gap fill.

Are There Other Assets Where Gap Fills Occur?

Yes, gap fills are not limited to stocks. They can occur in other asset classes like commodities, forex, and even cryptocurrencies. Examples include price gaps that get filled in precious metals or currency pairs.