How to trade Gaps

By | July 16, 2010

Today as i saw the trading move in TCS on earning surprise i thought of writing on gap trading as TCS you can find many gaps formed.

What is a Gap?

Change in price levels of a stock/index between close and open of two consecutive days. It can also be defined as a pattern where no trading has occurred.Gaps can form in any time frame,mostly are useful for swing traders.

Why Gaps are Formed?

This happens because buy or sell orders are placed before the open that cause the price to open higher or lower than the previous day’s close.Gaps might happen because of earnings surprise,Good/Bad News from management and there are flood of orders either on upside or downside which forces the stock to open either gap up or gap down.
To summarize the above
  1. Gaps are formed to cause maximum pain to traders ie. maximum amount of loss to leveraged traders/short term traders.
  2. To keep people out of a major move so that we may see a follow through buying by amateur traders.
  3. Reaction of overnight news ie.Global cues from US,Europe and Asian Stock Market.
Opening gaps occur when the opening price “gaps” above or below the previous close.
One of the famous Gap was formed on Nifty was on 20th May 2009 where We opened a Gap up of 20% because of a exceptional news on Formation of India Government at center.
Lets take an example to get more calrity:
I have included the example of TCS. It came out with earning last Thursday and it was a big surprise to market results TCS opens at RS 795 on Friday while on Friday it closed at 782 an opening gap of RS 13.

I have also mentioned the Gaps with a Blue Circle on Daily charts.

Let have a look at opening gap down

Example is of Bharat Forge Stock Closed at 260.3 but the very next day opened at 258.3 and made a void or opening gap down of Rs 2


Filling The Gap

Now many times of Blogs/Newspaper/Business News Channel most of the readers have heard about of terms Filling the gap.What does this term indicates.Lets again have a look  at TCS chart

In Blue circle i have mentioned the Gaps,there are almost 3 gaps formed by TCS on daily chart.

If we look at first gap which was formed when TCS gaped up from 719 to 728 on some good news and moved up to 800+ levels but it retraced back  in few trading sessions and filled the gap.This is know as Filling the gap.

I have mentioned one more example of Filling the gap in TCS.Quite often, prices will retreat to fill a gap in a bull market before continuing the move. Likewise, prices often rally in a bear market to fill gaps.

All gaps are filled is not a trusim,Sometime gaps are never filled for years as The gap Nifty has formed on 20th May 2009 and till now it has not filled.

For trading purposes, we define four basic types of gaps as follows:

  • Breakaway Gaps –  Breakaway gaps often occur after a stretch of sideways trading . Most traders out of the move when these type of gaps occurs and usually precedes a major move. This type of gap may remain unfilled for a long period of time. In some cases these gaps may never get filled.The gap Nifty has formed on 20th May 2009 and till now it has not filled.
  • Continuation Gaps – Sometimes called runaway gaps or measuring gaps, these occur during a strong advance in price.
  • Exhaustion Gaps – This type of gap occurs in the direction of the prevailing trend and represents the final surge of buying or selling interest before a major trend change.

3 thoughts on “How to trade Gaps

  1. Chandra Mohan Gupta

    Dear Sir,

    Unable to understand which data (i.e NS or NF) we should understand more reliable from technical point of view as no gap in NS & huge gapup in NF on 18th May, 2009.

    Please clarify.

  2. Bramesh Post author

    Dear Sir,

    Please repeat the same exercise on NF data.You will see the gap.

    Rgds,
    Bramesh

  3. Chandra Mohan Gupta

    Dear Bramesh,

    As per Nifty data up closing difference of 651.5 points (4323.15-3671.65) was observed on 18th may, 2009 and not on 20th may, 2009 as mentioned in your article.

    Also Low/open price (3673.15) of 18th May was lower than the high price (3686.25)of the preceding trading day of 15th may, 2009. So in my opinion there exist no gap as per Nifty spot data.

    Data of Nifty spot is given below for your reference from 14th may to 21st may, 2009.
    Date Open High Low Close
    May 21, 2009 4,270.35 4,319.00 4,199.20 4,210.90
    May 20, 2009 4,318.75 4,362.85 4,244.70 4,270.30
    May 19, 2009 4,324.95 4,509.40 4,167.65 4,318.45
    May 18, 2009 3,673.15 4,384.30 3,673.15 4,323.15
    May 15, 2009 3,597.85 3,686.25 3,597.85 3,671.65
    May 14, 2009 3,631.90 3,631.90 3,537.60 3,593.45

    Please clarify me, if I am wrong.

    Thanks and regards.

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