Custom Search

Can Gaps Make You Money?

Gauging Gaps

Should you trade the gap? Here are some gap performance numbers to help you decide.

by Thomas N. Bulkowski

Suppose you've been following a chart pattern. Say prices gap upward, piercing the trendline in a breakout. Do you buy the stock,   expecting an unusually large gain? How long will it be before prices return and close the gap? I will address those questions here.

GAP TYPES

Prices gap when today's high is below yesterday' s low, or today's low is above yesterday's high. A chart of the pattern will show a gap between the prices. There are five types of gaps: area, breakaway, continuation, ex-dividend, and exhaustion. Figures 1 and 2 show examples. Common and pattern gaps are synonyms for the area gap. As you can see in Figure 1, area gaps appear most often, usually during a sideways price trend. Prices usually, but not always, close the gap quickly, meaning that they return to the gap location and span it completely, filling the hole left by the gap. For example, the area gap in November closes a week later,   but the early December breakaway gap doesn't close until almost February.

Exhaustion gaps typically appear at the end of a straight-line run, as they did in December and October. Measuring and runaway gaps are synonyms for the continuation gap. Figure 2 shows an example. It's a rare gap, and it too makes its appearance during straightline runs, with prices continuing to move in the prevailing direction.

GAP IDENTIFICATION

Figure 3 shows the identification guidelines forgaps. To describe them more thoroughly:

Area gap. The area gap occurs most often. It looks like a breakaway gap at first, but it closes quickly. Volume may be heavy the day the gap occurs, but usually returns to normal in a day or two. Look for a sideways congestion or consolidation region   spawning the gap. It's as if prices pump pressure for the explosive move, but the pressure dissipates quickly. In some cases, a distinctive hooking pattern occurs. The early May area gap in Figure 1 shows this curling pattern when the gap closes two days later.

Breakaway gap. If there is one gap type to trade, it's the breakaway gap. Prices break out of a consolidation region on high volume, setting the stage for a ballistic, straight-line run. High volume typically persists for several days and the gap does not close quickly, which distinguishes it from the area gap. It's been said that the longer the congestion area preceding the gap, the more strength the breakaway will have, but I haven't researched this to know if that's true.

IDENTIFICATION GUIDELINES GAP TYPE IDENTIFICATION

Area, common, or pattern Look for a congestion area preceding the gap. Volume may be high, but it returns to normal quickly. Sometimes prices gap, then curl around in a distinctive hooking pattern, closing the gap in a few days. Area gaps tend to be short.

Breakaway A gap associated with high volume at the start of a straight-line run, usually after the breakout from a consolidation area. High volume may continue for several days.

Continuation, measuring, or runaway Occurs in the middle of a straight-line run on high volume. Measure from the trend start to the gap and project upward to predict where prices will stop.

Ex-dividend Prices gap downward when the stock pays a dividend, but price action during the day usually closes the gap.

Exhaustion Often a large gap signaling the end of a straightline run, accompanied by high volume. Prices sometimes retrace and close the gap quickly.