How to Profit from Stock Gaps?

Before we start to wonder how much we can profit from gaps in stock trading, we need to first get a hold of the basics. So, what is stock gap? A stock gap is when there’s an actual gap in the trading activity of a stock.

On a chart, this appears as a huge gap between the graph’s crests and troughs without any trading activity in between. This is for the duration when there was zero trading activity for the stock. Normally, this would happen between two trading sessions or patterns but can happen at other times too.

So, what does this mean to you? Depending on the type of gap involved, you can adjust your strategies so that they benefit you the most. You can also trade in gap filling stocks to best position yourself in a profitable trade, but more on that later.

On your end, you’ll see a sudden increase or decrease in the stock’s metrics despite a complete or major pause in trading.

Let’s see why that matters!

What are Stock Gaps and How Do They Work in Trading?

So, what is stock gap, and why it matters to traders? Simple, a gap is a sudden overnight change in the sentiment around a stock. Let’s say a piece of news compels lots of traders to buy/sell a stock by the close of the day.

Now, when these traders come back to the trading screen for the following day, they’ll see something peculiar. The stock’s charts will be up or down sharply as compared to the previous day without any trading activity in between.

Why?

Well, because they all bought into the trade (or sold the stock) at once. This shift in sentiment thus creates a “gap” between the chart extremes from the day before and the next day. Stocks gapping up thus give you a clear indication of where the market’s sentiments rest for the day.

Another factor is the performance of the stock itself — the better it performs, the greater the gap will be. If the gap falls within the market average from the previous day, then it’s called a partial gap. Otherwise, it is called a full gap.

Understanding Stock Gaps: Strategies for Trading

You can go ahead with trading gaps and benefit from sudden shifts in the price patterns of the stocks you plan to use. When you see stocks gapping up pre-market, it’s time to play your trade to maximize your returns.

After a gap, the price may sharply increase or decrease — you need to know which is more likely to play your trade. The first indicator here is the type of the gap itself. For instance, continuation gaps and exhaustion gaps tend to move in opposite directions.

You must also monitor the volume and see if it aligns with the type of gap in question. For instance, if you spot an exhaustion gap, make sure that the volume is also low. In the case of breakaway gaps, however, the opposite must be true under ideal conditions.

But there’s one stage before all of this as well. How to know if a stock will gap up? Most traders wait for some time after a company has unveiled its positive earnings report. Then they buy into the stock in hopes that others, like them, will feel positive about the stock.

But as soon as you see a stock gap filling up, move quickly to place your trade because time is short when that happens. Overall, trading gaps can be highly profitable (duh), but only if you call them in time and then benefit from the price shift.

The Psychology of Stock Gaps

Hopefully, this answers “What is gap filling in stocks?” However, one question remains to be answered: what goes on behind the curtains? What is the psychology behind these stock gaps and how can a gap scanner Thinkorswim help you?

We briefly mentioned some types of stock gaps earlier. Here, we’ll differentiate between all of them to give you some perspective:

  • Breakaway Gaps — these gaps lie between the end of a prevalent trend and the rise of the next one.
  • Exhaustion Gaps — these gaps occur at the very end of a given pattern to drastically affect the price pattern.
  • Common Gaps — these gaps have nothing to do with the price pattern, but instead, only show where the price has gapped.
  • Continuation Gaps — these gaps happen due to a sentimental shift in the market due to news or insights; when a huge volume of buyers or sellers rushes to a stock, a gap is almost inevitable.

You see it, right?

All types of stock gaps have different psychological triggers behind them (and in some cases, the intrinsic value of the stock becomes a factor). Just be sure to identify a gap before playing your trade on its back.

Next up, let’s see why do gaps always get filled, or do they?

Do Stock Gaps Always Get Filled?

So, do stock gaps always get filled? Mostly, yes, and when they do, it’s fairly quick. But this does not have to happen at all times. The most common exception to this is the case of breakaway gaps.

However, mostly, as soon as traders initiate the gap-filling action, stock gaps fill up inevitably. This is because there’s no resistance once the gaps begin to fill — nothing is keeping them from filling up.

Be sure to use an effective tool like the Thinkorswim gap scanner to spot an upcoming gap to profit the most from it.

It’s best to place your trade before the gap.

Gap Filling in Stocks: Strategies for Trading and Managing Risk

Once there’s a gap, you can profit from it as soon as it starts to fill up. But for that, you first need to find an opening or gap. You can either predict such an occurrence based on your experience or use indicators to spot stocks with gaps to fill.

Traders often use techniques like fading a stock gap to exploit a profitable opportunity.

Just be sure never to overdo things and not rely on your predictions alone. Use indicators and key metrics to minimize risk and never throw all your eggs in one basket. Also, be sure you know which gap you’re dealing with before you start trading.

That’s it from us, good luck with your trading career!

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