What is a Gap?
A gap is when a stock price closes the day at one price, and opens the next day above or below that price, and continues in the direction. You can identify this in a chart by looking for when a candle stick starts above or below the previous day’s closing price. The gap may be not be a small and common type, which may not be very meaningful, or it may be much larger and more significant, which we will cover in the following sections.
What Causes a Gap?
Due to the fact that stock markets close on weekends and also daily in the afternoon and open the next morning, these closures can cause gaps. Investors are allowed to put in orders for stocks after hours, but the order will not be filled until the market is open the next day. This results in the market matching up all of the buy and sell orders throughout the evening and the next morning, and trying to find matches for these trades when the market opens.
If the buyers are ordering significantly more stock quantities than the sellers, then price can open much higher the next morning due to the increased demand. Conversely, if sellers outweigh buyers by a majority, the supply is much higher than demand and therefore the price can gap down.
Gaps can occur when there is big news after the markets are closed such as the company announcing results in an earnings call. We saw this happen in the Amkor Technology Stock of the Day post. Alternatively, there could be big news about the industry in general or other world news that effects the public’s view of value in the security.
What Types of Gaps Exist?
Partial or Full Gap
Every gap that exists is either a partial or full gap. The four types of gaps below will always either be a partial or a full gap. Partial gaps occur when the opening price gaps up or down vs. yesterday’s close, but it is still in the range of yesterday’s trading.
Partial Gap (Below) Example: Yesterday’s stock price traded between $28.95 to $29.72 and closed at $28.96. Today, the stock opened higher at $29.28. Since it opened at a higher price, it gapped up. This was only a partial gap because the $29.28 opening price was within yesterday’s range of $28.95 to $29.72.
This is also an example of the “common gap” type which we discuss in the next section. It is a common gap because the gap up is quick, small, and also does not break through any specific support or resistance areas.
Full Gap Example (Below) (Apple, July 2020): Yesterday’s stock price traded between $93.77 and $96.30, it closed at $96.19. Today, the stock opened much higher at $102.88 and closed even higher at $106.26. Since it opened at a higher price, it gapped upwards.
This was a full gap because the open of $102.88 was above any price the stock had traded during the day before. You can identify this easily by seeing that the candle stick does not cover any of the same vertical axis as the day before.
This also happens to be a breakaway gap, as Apple hit a new high on this day. It also occurred right after Apple’s 2020 Q3 earning calls where they beat earnings by 26.25%. It shows how powerful the earnings calls can be for a company, and we see that it was a good sign as Apple continued to gain in share price in the coming days.
Common gaps are the most frequent, hence the name “common”. These usually change the price only slightly and do not carry much significance. The opening price is slightly different than the prior day’s close, but no meaningful movement has happened to suggest a trend.
Breakaway gaps are the gaps you want to look for if you are looking to enter into a position with the stock. These are the gaps that cross a meaningful threshold and therefore signal that the major opinion of the stock may have changed.
When breakaway gaps occur upwards, it means that the stock gapped up through a significant resistance line. We show an example of a breakaway gap above when explaining full gaps. If the stock gaps upwards past an area that has historically been particularly difficult for the stock to pass, this is a breakaway gap.
This upwards breakaway gap triggers a bullish signal, meaning it is the start of an uptrend in the stock. When this gap occurs, more often than not, the stock will see following weeks of additional gains in price. If you are good (and lucky) enough to get in on a breakaway gap, hold on tight for them gains! But be careful not to overextend and be caught in an exhaustion gap!
Breakaway gaps can also occur in a downward trend. All of the same rules and triggers apply, but in the opposite fashion. A breakaway gap downward is a bearish signal and signifies that the stock is likely to move further down in the coming weeks. Some investors take this as a chance to short the stock, betting that the price will continue lower.
Runaway gaps occur when a trend has already been established. If an uptrend has been occurring and there are subsequent gaps up in the same direction, these are what we call runaway gaps. These are the price movements that you really are looking for if you have bought a stock after seeing the first breakaway gap.
If a stock has a breakaway gap up, often times you will see runaway gaps up following it in the coming days after the breakout. This is also why it is important to recognize breakaway gaps downwards in stocks you already own. If the stock gaps downward through a support line, you usually want to get out of the position in case further runaway gaps form even lower price points.
In May 2018, Apple stock shows the perfect example of runaway gaps after a breakaway gap has occurred. In the above image we see a breakaway gap up occur on none other than another earnings call! See a trend here?
Apple broke through the 200 day moving average line after an earnings call, causing a breakaway gap. Three of the four next days saw runaway gaps form, as the stock continued to open at prices higher than the previous day’s close. This is a perfect example of how powerful that initial breakaway gap can be at starting a trend.
The final type of gap is an exhaustion gap; these are the bad guys. If you are long on a stock and you see an exhaustion gap, its time to think about selling if you are not in it for the very long term.
Near the end of a trend, an exhaustion gap sometimes occurs. This essentially is the last attempt to push the stock further in the direction of the trend, but has been met with resistance. This usually happens after the stock price has moved in one direction for quite some time already.
The final batch of investors who feel they are missing out on the opportunity, start to trickle in because they have FOMO (fear of missing out). At this point in the trend, there are not enough investors to push the stock further. In the example of an uptrend, when this gap occurs, it means people are ready to sell and take their profits. Sellers start selling, the price of the stock doesn’t climb further, and the trend begins reverse and move the opposite way during the next few weeks.
We see two exhaustion gaps after Apple’s latest uptrend. The high volume shown at the bottom reinforces the power of the exhaustion case in this case. The following days show further deterioration of the stock price.