What is Gap Up and Gap Down in Stock Market Trading?
When you venture into the world of investment, especially stock investment, you should understand certain terms and their implications so you can make informed trading decisions. In light of this, some of the commonest terms include “Gap Up” and “Gap Down”, used frequently. Simply put, these refer to sudden movements in the price of stocks between trading sessions. So, for example, gap up stocks reflect those stocks that have a higher price in the current trading session compared to the last trading session.
Thorough knowledge of these terms helps traders gain insights into stock prices and their movement from one trading session to another. In the following article, be prepared to learn relevant information about gap up and gap down stock, the kinds of gaps, and considerations, if you wish to use concepts in trading strategies.
Gap Up Meaning
Simply put, in a gap up scenario, the opening price of a stock is higher than the closing price of the same stock in the previous trading session. Such stocks are popularly referred to as gap up stocks. Additionally, a gap up event may occur due to many factors including robust financial reports of the company whose stock is trading, or positive company, sector, or industry prospects. Furthermore, if the overall stock market mood is positive, such gap up situations may occur.
Gap Down Meaning
Now you know when gap up open stocks occur. In contrast, a gap down situation occurs when the opening price of any given stock is lower than its closing price in the previous trading session. This circumstance occurs due to certain factors like the poor financial performance of the company, negative company news, unfavourable market conditions, or political unrest. It can also happen because of natural calamities.
Types of Gaps in the Stock Market
In terms of gap up stocks and gap down stocks, there are specific types of gaps that occur (and are referred to as such) in trading sessions, according to a stock’s price fluctuation. Investors should know about the following types:
Common Gaps
These gaps show when the price has changed between trading sessions, whether it has gone down or risen.
Exhaustion Gaps
These typically appear after a strong market trend. The gap appears as a final surge in a stock’s price in the direction of a trend. A revered trend may follow.
Breakaway Gaps
A breakaway gap is observed when a stock’s price tends to break away from a long-standing range of trading. The occurrence implies a fresh trend, with stock prices prone to go upwards or downwards. So, you may see gap up stocks or gap down stocks. Traders can spot such patterns through stock price charts where they see typical wedges or triangles.
Continuation Gaps
Continuation gaps tend to occur in the middle of any market trend. What this reflects is the collaborative expectation of sellers or buyers regarding the future direction of the given stock.
Full or Partial Gaps
Full or partial gaps can be viewed about gap up and gap down stock. This is how these gaps occur:
- Full Gap Up - Such a gap occurs in a situation where the opening price of a stock is higher compared to the closing price of the stock in the previous day’s session.
- Full Gap Down - This occurs when the opening session’s stock price is lower relative to the stock’s closing price in the previous day’s session.
- Partial Gap Up - If the stock’s opening price is higher than the stock’s closing price in the previous session, but is not higher than the previous session’s highest stock price, this gap will occur. Hence, these stocks are not complete gap up stocks.
- Partial Gap Down - If the stock’s opening price is lower than the stock’s closing price in the previous session, but is not lower than the stock’s lowest price in the previous session, this gap is observed.
Characteristics of Gap Up and Gap Down Stocks
Gap up open stocks and gap down open stocks have certain common characteristics and a few which set them apart. Key characteristics are highlighted below:
- High Volatility - Gaps in the stock market are associated with increased trading volume relative to what is normally seen. Additionally, they are prone to high volatility in price as traders respond to events/new information acting as triggers for gap occurrence.
- Potential Continuity of Trends - In case a gap up and a gap down are a part of a continuing trend, existing currently, the stock may show momentum in the trending direction.
- Resistance and Support - Gaps are likely to reflect levels of resistance and support. This is because stock prices may be exposed to buying or selling pressure when trying to fill gaps.
What causes a stock to gap up or gap down overnight?
Gap up open stocks or gap down open stocks can occur overnight, as well as in a day trading session. There are different reasons for this:
Company Earnings Announcements
Reports from companies, reflecting negative or positive earnings news can crucially affect the price of a stock, resulting in a gap down or a gap up, respectively, at market opening time.
News of the Economy
Significant or sudden changes in certain economic factors like employment figures, GDP, or interest rates can impact the sentiment of the market, thereby triggering stock price gaps.
Events of a Geopolitical Nature
Gap up stocks or gap down stocks may be created due to relevant international or political circumstances like natural disasters, trade disputes, or elections, creating an uncertain market atmosphere and causing gaps in stock prices.
Mergers/Acquisitions
News releases of divestitures, acquisitions, and mergers may cause major shifts in stock prices and gaps may occur.
Trading Strategies for Gap Up and Gap Down Stocks
Traders can use some key strategies while engaging in trading with gap up stocks and gap down stocks. These are highlighted below:
- Trading with Gaps: Traders make trades in the same direction as a gap and attempt to make profits, as they expect prices to continue in the gap’s direction.
- Fading the Gap: Here, traders take a position contrary to the position of the gap. This is because they estimate that the stock’s price will ultimately retrace, filling the gap.
- Trading with Other Indicators: Traders tend to use gaps, blending them with other trading strategies/technical indicators like oscillators, support and resistance lines, and moving averages to make informed trading moves.
- Filling the Gap: Gap up and gap down stock trading can employ a strategy in which gaps are tracked. The aim here is to wait for the stock’s price to achieve the level at the pre-gap period and then trade, assuming that gaps get filled over time.
Things to Consider When Gap Trading
If you wish to execute a gap up and gap down method while trading, there are some fundamental considerations:
Understand the Meaning of Gaps
At a time when any stock fills any gap, the stock continues to move because of a lack of resistance or support from the market. This must be a consideration while planning any strategy to be used because gaps are prone to represent areas in which there is no support or resistance.
Do Trend Analysis
Before you think of trading on a gap, you must conduct a trend analysis. Typically, gaps are indicative of the beginning or end of trends. Additionally, each gap has a distinct interpretation, and this could affect your trading plan. Furthermore, while trading on a gap, you will be better off if you familiarise yourself with intraday trading strategies.
Don’t Make Hasty Decisions
Traders often feel like rushing into a trade when they see a gap. However, this can prove to be misleading. Several gaps, by their very nature, are temporary. They last for a short while. Hence, it would be better to be patient and make an analysis of the gap before trading.
Identify Gaps Appropriately
Whether traders wish to make the most of gap up stocks or gap down stocks, they must identify gaps in the right way. Furthermore, the recognition of a certain kind of gap can be a bit tricky. For instance, breakaway gaps and exhaustion gaps can seem similar. However, the consideration of volume may help to distinguish them.
Conclusion
An occurrence of a gap up or a gap down is a common event in the realm of the stock market and stock trading. Gaps provide traders with masterful insights into trading prospects and market dynamics, including the sentiment of the market. Understanding gaps, trading patterns using them, and kinds of gaps, can help you to make informed decisions regarding your trading journey.
FAQ
Is the gap bullish or bearish?
A gap-up occurrence is considered bullish and a gap-down situation is considered bearish.
How do you know if the market will open a gap up or a gap down?
A market may open with a gap up if there has been some positive news (like profitable earnings releases) of the company, good news about the economy, and other favourable factors that make the stock price high in the next trading session. There may be a gap down occurrence in the next trading session if there is negative news about a company’s stock before the opening bell.
Why do stocks open a gap up and a gap down?
Stocks open a gap up when the prices of stocks open higher in a subsequent session of trading compared to the previous session, potentially due to favourable factors taking the stock’s price higher. The reverse happens in a gap down situation when unfavourable conditions affect a stock’s price in a trading session, and the stock price is low compared to the closing price in the previous trading session.