What is Gap Trading?
A gap occurs when a stock's price opens significantly higher or lower than the previous day's close, creating a visible gap on the chart. Gap trading strategies attempt to profit from how these gaps resolve.
Gap Trading Explained
Gaps are caused by overnight news, earnings, or pre-market trading activity. There are four types: breakaway gaps (start of new trend), runaway/measuring gaps (middle of trend), exhaustion gaps (near end of trend), and common gaps (get filled quickly). The strategy of 'filling the gap' — betting that price will return to the gap area — works for common and exhaustion gaps.
Real-World Example
A stock closes at $50 and opens the next day at $53 on moderate earnings news. A gap trader might short the stock expecting it to fill back to the $50 level. They'd set a stop at $55 and a target at $50.50.
Related Terms
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