Stock Gaps: Discover the 9 Main Types & How to Pounce on Them

What is a Stock Gap?

A stock gap is a space in the chart of a security, where trading opens above or below the prior closing price. The space between the open and the prior close defines the gap.

Gaps in stocks, forex, and futures happen regularly. Full market gaps happen less frequently, but they're common in times of high volatility or economic uncertainty.

Trading gaps can be scary, exciting, or both. It can be difficult, but gaps present some of my favorite opportunities. By the end of this, you should be less scared and more ready to start studying and using gaps in your trading. 

The secret to stock gaps is understanding the context of each gap. You want to have a firm grasp on that before you try trading gaps. In this guide, we'll cover:

• The types of gaps, why they might happen, and where you can look for trades.
• Possible meanings of different types of gaps, and common myths about those meanings.
• Price action around gaps, explanations for it, and ways to take advantage of it.

Why Do Gaps Happen in Stocks?

Stocks can gap for a wide variety of reasons. Just a few of those:

• The company released news or earnings results after the market closed or before the open in the morning.
• Momentum of the stock was strong enough that traders rushed in or out during the extended session (ECN trading between close and open)
• A large trader(s) sold or bought a big position(s) through an on-open order.
• The sector in which the company operates had some high-impact news affecting the whole sector.
• Economic data releases caused the whole market to gap down or up.
• Sometimes, for no clear reason at all.

Avoid getting hung up on why a particular gap occurred. Knowing why it happened is only a small part of understanding the context and trading it. And, gaps are often wrong, meaning the gap would get filled.

So you don't want to get married to an idea of why a stock gapped or didn't gap. We can't really know for sure. There are too many market participants.

Too many traders tell themselves a nice story about why a gap happened. They get invested in that story, and they lose big. And/or they miss the opportunity to trade it properly, with high probability and good R/R.

What Does it Mean When a Stock Gaps?

Any time a stock opens higher or lower than it closed, that creates a gap. That gap is the difference between the opening price and the prior closing price. Technically, any small difference makes a gap, but most traders only refer to larger price differentials as gaps.

The first question you have to ask, is does this gap mean anything at all?

While a 0.05% gap in a stock is still a gap, it's not usually one worth talking about. A 0.5% gap may or may not be an event worth trading. Gaps of 1% or more are significant and may provide trading opportunities. 

In low-dollar stocks and penny stocks, the above percentages don't really apply. a $1.00 stock gapping up 1 cent is not significant. A $5 stock gapping up 5 cents is rarely significant.

But a $50 stock gapping up 50 cents (during normal volatility) may be significant. A $50 stock gapping up $5 is definitely significant.

Interpreting a Gap

When you see a significant gap, you should start looking at the context. What else is going on with the stock?

• Has there been any news or data released recently by the company?
• Was their sector impacted by some news or economic event?
• What technical observations can you make about the stock, before and after the gap?
• Where is the gap in relation to past prices? What was going on the last time price was here?
• What important levels are nearby, inside and outside the gap?

All of these things help you interpret the meaning of the gap and spot potential opportunities.

What are the Main Types of Stock Gaps?

Most explanation of gaps cover four main types of gaps. Based on my trading experience, we're going to cover nine types of gaps. This should give you a better understanding so you can dive deeper into trading gaps - or avoiding them.

Market Gaps

Market gaps occur when the entire 'market' gaps up or down. When traders say 'the market', they mean the indices. The S&P 500 and the Nasdaq are the indices most traders follow and trade. 

Other indices like the Dow Industrial Average, Russell 2000, FTSE 100 (Europe) or Hang Seng (China) may also be referred to as 'the market', but less commonly.

What Causes Market Gaps?

Market gaps often result from events like world news, economic data releases, and macroeconomic news. They are especially common during times of economic turmoil. As economic strife works its way through the system, certainty falls, and volatility rises.

World News Events

You can see how this played out by looking at the market beginning with the start of the COVID-19 outbreak in 2020. 

[image of market gaps dropping in 2020]

Economic Data Releases

In 2022 when the fed began focusing on inflation, you saw market gaps in reaction to inflation data releases.

Common Gaps

Common gaps occur with no obvious reason or catalyst. A stock gaps without news or data propelling it, just investor supply/demand. 

Sometimes, this gap is caused by a less-obvious event, like a market imbalance in the stock. That happens when the on-open orders for a stock are "off-balance" largely in one direction. This can be caused by a person or entity placing a large order to buy or sell through the opening print. Or, by many market participants combining to have a similar effect.

[image of some small gap in a stock]

News Gaps

Stocks gap on news more than anything else. Earnings surpass or fail to meet expectations. Companies update their sales forecasts. One company announces they've taken a large stake in another. 

Most of these announcements come outside of normal market hours. They may come during the extended trading session (ECN trading only, 4pm ET - 7pm ET or 4am ET - 9:30pm ET. Or they may hit the wires in the hours in between those.

When news hits the market during these times, post-market traders and pre-market traders react. They may move stock prices significantly, which is easier during those times due to lower volume.

Gaps can also occur without that pre- or post-market trading. The prices at which people are willing to buy and sell on the open change with their interpretation of the news.

Trending Gap

Trending gaps happen when a stock gaps with its current trend. They often have no obvious catalyst. But sometimes they're caused by an analyst upgrade or company news.

They look just like they sound - The gap goes with the trend. For example, a stock that is trending up over the short-term and intermediate-term gaps up.

Recognizing trending gaps has important implications when learning how to trade gaps.

This is one gap you probably don't want to fade. Shorting a gap against two concurrent uptrends, for example, can be very dangerous. On the other hand, learning how to trade with the gap in this instance can lead to some great opportunities.  

Cross-Trend Gap

As it sounds, the cross-trend gap is the opposite of a trending gap. These stock gaps go against the current trend. So if a stock is trending up, a cross-trend gap is a gap down.

Cross-trend gaps present great opportunities as well, and I prefer these to trending gaps.

Playing gaps that go against the trend:

When a stock is trending up on multiple timeframes and gets a gap down, it can be a great opportunity for a gap-close trade. This works best when a trend is strong, typically earlier in the trend.

For example, Tesla trended up in 2020 after the initial covid scare. I woke up to Tesla gapping down many mornings. For a day trader, many of these were buy opportunities.

Note: This is just one way cross-trend gaps can be played, and though it may sound easy, it's not. As with any setup, you should study it and see if you can find an edge. Trading gaps takes a special kind of confidence in your setup. You're dealing with a wider range and more volatility.

The Short-Relief Factor

The Short-Relief Factor is my name for one of the dynamics that makes me seek long setups here.

Many traders who have been shorting against the trend will get relief from a gap down and seek to cover on the open. This creates buying demand, causing price, which can cause more short covering. 

You may find that before long, the gap fills, and the stock may even continue higher.

Exhaustion Gap

An exhaustion gap is a cross-trend gap down with two additional features:

• It follows a quick rise in the price of a stock over the preceding weeks. Sometimes a parabolic or exponential rise.
• It typically happens later in a trend.

It's called an exhaustion gap because some technical traders see it as a sign a trend is ending. I don't trade based on this, but some swing traders find it useful as part of their analysis.

In the below example of Tesla gaps, you can see the rapid 30% rise in two weeks, with several gaps up, followed by the exhaustion gap on 1/11/21

Runaway Gap

Sometimes stocks have runaway gaps, skipping one price point after another. 

Newer traders are often tempted to fade these gaps, thinking "it's gone too far". But be careful. Stepping in front of these can be like stepping in front of a runaway train.

Runaway gaps can happen to the upside or the downside. But, you rarely hear people refer to sequential gaps down as runaway gaps. Maybe it's because stocks can only runaway for so long to the downside, but a hot runaway stock has much more room to climb. 

Breakaway Gap

Breakaway gaps happen when a gap brings a stock outside a support or resistance level. This sometimes happens after stocks consolidate or spend an extended time inside a trading range.

A breakaway gap down occurs when a stock opens below the prior close and below a support level. A breakaway gap down is the opposite, gapping up above a prior resistance level.

Breakaway gaps can provide trading opportunities. But they're best when they match one of the other gap types above. For example, a trending gap that is also a breakaway gap.

Trading Halt Gap

Trading halt gaps occur intraday in stocks experiencing high volatility. To have one, the exchange (the computers) must first halt the stock.

That could be a volatility halt, or it could be a news-pending halt. Either way, the stock closes for some period of time, and re-opens later in the day.

The space between that halt price and the re-opening price is the trading halt gap. 

Trading halt gaps can present opportunities, but it's akin to playing with fire. 

High volatility is just the start. Often the order book becomes thin, and order flow is erratic.

As rules have changed and computerized trading has become more prevalent, it's more common to see runaway trading halt gaps. Sometimes those later reverse and runaway in the opposite direction. The last thing you want to do is get caught on the wrong side of one of those. 

Liquidity Voids

Liquidity voids aren't gaps in the technical sense, but they often trade like gaps.

Liquidity voids are large ranges through which price moved quickly with little contest. This rapid movement creates a "soft spot" in the stock that can behave similarly to a gap, in that it may "want to be filled" before price continues.

Is it Good if a Stock Gaps Up?

It can be "good" or "bad" for a stock to gap up. It all depends on how you want to trade it. In the traditional sense that the public benefits from a stock going up, a gap up would be considered good.

But remember, a gap up doesn't mean the stock will keep going up. Gaps sometimes "want to be filled". So don't get too excited thinking every gap up is a "gap and go" setup.

Furthermore, gaps should be a sign you need to re-evaluate your plan. Stock gaps, especially large ones, make trading more difficult. Gaps can throw a wrench in trading plans and force you to adapt or sit on the sidelines.

How Often do Stocks Fill Gaps?

How often gaps fill depends on three factors:

1. Size of the gap
2. Length of time allowed for gap to fill
3. Whether the gap is up or down

Since stocks trend up over time, on average, we can expect gaps down to fill more often than gaps up. Market gaps down fill at 100%, historically, as long as you give them enough time. 

Even though that is true for the past, that doesn't mean it will be true for the future.

Why do Stocks Need to Fill Gaps?

Stocks don't necessarily "need" to fill gaps. Stocks do tend to want to fill gaps, though, at least partially. But why?

Stocks fill gaps for various reasons, and those vary based on:

• The type of gap
• Timing of the gap
• Price action leading up to the gap
• Company news, market conditions, economic conditions, and more.

When gaps fill gaps quickly, here are a few reasons that may explain it:

• Gaps leave untested price "holes" that the market wants to test
• Gaps provide opportunities for profit taking on the open, which can move price into the gap
• Once price is in the gap, it has less resistance/support to stop it from filling the gap.

Gap Trading: How to Trade Gaps

There are really two ways to trade gaps, when you break it down. You can fade the gap (trade in the opposite direction of the gap). Or, you can follow the gap (trade in the same direction as the gap).

Which you choose is up to you and your strategy. How you apply your strategy is also up to you, but here's a quick overview:

1. Identify the type(s) of gap you're looking at
2. Study the context of the gap. What happened in the days and weeks leading up to it? What are the short-term and intermediate-term trends doing?
3. Frame it like you would any other setup. Where is your target? Your stop loss? Is your desired R/R there? What are the reasons it might not work? Have you studied this setup before? Should you do that before trading it (yes)?

Gap Trading: Getting Started

Gap trading as a strategy is more difficult than other intraday setups. But, the opportunity and R/R can be very favorable in some cases, and you can learn to spot those.

Don't just jump in every time you see a gap.

Study gaps and their behavior. Note the context around each gap and how it played out. Get a good grasp of the volatility and price action for these setups before you jump in.

Risks of Gap Trading 

Gap fill trading will test your emotions more than some other setups.

You know how sometimes you get stopped out on a candle wick, and then price rages in your favor? Gap fill trades are notorious for this.

Price can move very quickly on the open, and you can get stopped out in a heartbeat, then have to sit and watch your trade play out without you.

Regulation NMS

With stocks and index futures, this is more exaggerated because Regulation NMS is suspended during the first 15 minutes of trading. That means market makers in stocks can print any price they want for market orders or crossed orders.

They don't have to print the National Best Bid / Best Offer. This allows wild price action, and you can get stopped out in a millisecond. 

Gap Fill Trading

Gap fill trading means fading the gap in hope of a full or partial gap fill. Personally, this is my favorite gap strategy.

But, there's a time and a place for gap fill trading. I don't fight the trend.

Gap and Go Trading

Gap and go trading follows the direction of the gap, hoping momentum will carry price higher. It's more popular, although in my opinion it's more challenging.

With gap and go setups, your stop often needs to be wider. Even when gaps "go", they don't usually do it right away, and you have a lot of range below in which they can trade around before going higher. 

This makes gap and go trades harder to frame and can lower the win-rate even when you're "right".

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