A gap is a price range in which no shares (stocks) or contracts (futures and options) are transacted. A gap up occurs when the low of day 2 is higher than the high of day 1.
On the contrary, a gap down occurs when the high price of day 2 is lower than the low of day 1.
Filling the Gap
Filling the gap means that the price bars that follow the gap have price levels that are the same price levels that were missing transactions between buyers and sellers and which made the gap by definition a gap.
Types of Gaps
There are many types of gaps in technical analysis: breakaway, continuation/runaway, exhaustion, common, and opening.
The breakaway gap occurs when prices breakout from a trading range (area of prices with an established support and resistance line) and begin a new trend. To be more specific, Kirkpatrick & Dahlquist (2010) assert that the breakaway gap should establish a new high (for a breakaway gap up) or new low (for a gap down) for the past 20 days and that any retracement downward (for a gap up) or upward (for a gap down) should not completely fill the gap (p. 364).
Rockefeller (2011) identifies two important traits of the breakaway gap: First, the gap should be proportionately big to the normal trading range (high price of price bar minus low price of price bar), therefore if the normal trading range for a stock is $1, then a gap up or down of $5 is big; Second, a breakaway gap occurs after a period when prices are trending slightly or moving horizontal (p. 125). Kirkpatrick & Dahlquist (2010) state that "The size of the gap appears to be proportional to the strength of the subsequent price move" and an increase in volume is associated with gap ups but not always with gap downs (p. 364).
When trading the breakaway gap, Bulkowski (2005) suggests trading in the direction of the gap (i.e. gap up means buy, gap down means sell short) with breakaway gaps that are accompanied by high volume; he also states that large gaps outperform smaller gaps.
Continuation or Measuring or Runaway Gap
The runaway gap or continuation gap occurs in an already existing trend and suggests a future continuation of that trend. The runaway gap is also called a measuring gap because the gaps location can be used to predict a price target. In an uptrend with a runaway gap up, Bulkowski (2005) states that on average, the gap's center (Top of gap minus bottom of gap) occurs 43% of the way from the beginning of the uptrend to the end of the uptrend; similarly, a runaway gap down occurs on average 57% of the way from the beginning of the downtrend to the end of the downtrend.
The exhaustion gap is similar to the runaway gap. If a runaway gap is filled within a few price bars after the gap, then it likely is an exhaustion gap. With an exhaustion gap, prices either consolidate horizontally or reverse downward.
Common gaps are gaps that do not breakout from a trading range (unlike a breakaway gap) and are quickly filled (unlike a runaway gap). Rockefeller (2011) uses volume as a guide for common gaps, she states that common gaps typically have low volume, because low volume means other traders are not jumping on the bandwagon, creating a new trend (p. 124).
An opening gap is a temporary gap that changes its name by the end of the close. An opening gap occurs when prices open above or below the trading range of the prior day, the opening gap either fills the gap (essentially eliminating its gap status and becoming a regular price bar) or continues moving in the direction of the gap until the close of the day creating one of the other breakaway, runaway, exhaustion, or common gaps. Kirkpatrick & Dahlquist (2010) research claims that when a gap is not filled within the first half hour of trading, the odds are increased that the trend will continue in the direction of the gap.
Gaps Chart Example - All Gaps
The chart above of the 20+ Year Treasury Bond illustrates all four of the gap types. The first part of the chart contains a common gap. Notice that there is an uptrend followed by a two day retracement downward prior to the common gap. The opening of the price gap was 3.2% (Price bar close prior to gap minus Price bar open following the gap). Note that within six days after the gap, prices filled the gap. This is a common gap because the gap moved opposite the direction from the prior trend eliminating it being called a runaway gap; and did not break out above or below the previous trading range, eliminating it from being called a breakaway gap.
Next is a breakaway gap. The price after the gap exceeded the previous three peaks that created the upper resistance line of the trading channel. The opening of the price gap was 2.5% (post gap price bar open minus prior to gap price bar close). In addition, the move (upward) after the gap moved in the same direction as the gap direction (upward).
The subsequent gap is a runaway or continuation gap of 2% because the gap direction (upward) occurs in the same direction as the prior trend (up) and the price movement after the gap moves in the same direction as the gap's direction (upward). Do note that in this example, the runaway/continuation gap is sometimes called a measuring gap. It is called this because when a runaway gap occurs, traders can guess (or measure) the eventual end of the trend by approximately doubling the distance between the beginning of the trend to the middle of the gap. In the chart above, the pivot low to the pivot high was 33% and the middle of the breakaway/continuation/measuring gap was 15.3%.
The final gap is the exhaustion gap. In the chart above the exhaustion gap occurs after the measuring gap and is 3.7%. Price moves after the exhaustion gap in the direction of the gap (upward), but only shortly (two days). Thereafter, prices decline. Eleven days after the gap, the gap is filled and the label exhaustion gap is assigned to the gap. Prices are expected thereafter to sink further down because the gap occurred late in an uptrend and the gap was filled.
- Nison, S. (2003) The Candlestick Course. Hoboken: John Wiley & Sons.
- Nison, S. (1994) Beyond Candlesticks: New Japanese Charting Techniques Revealed. New York: John Wiley & Sons.
- Nison, S. (1991) Japanese Candlestick Charting Techniques. New York: New York Institute of Finance.
- Rhoads, R. (2008) Candlestick Charting For Dummies. Hoboken: Wiley Publishing.
- ThinkorSwim. (2011). ThinkorSwim Resource Center: Candlestick Patterns Library.
- The Pattern Site. (2005). Bulkowski's Price Gaps . Retrieved June 1, 2012, from http://thepatternsite.com/gaps.html