Gap Trading Strategies: How to trade gaps in stocks?



For novice traders gaps are not easy to digest due to sheer psychological reasons but seasoned traders know it's importance and how to trade it. An active trader should know the basic Gap trading strategies as they are simple to apply and produce positive outcomes most of the time. 

If you have been wondering what is meant by a gap then here is the simple definition. A gap is a change in price levels between the close and open of two consecutive days. In trading terminologies there are in general four types of gaps - Full Gap Up, Full Gap Down, Partial Gap Up, Partial Gap Down.

A Full Gap Up occurs when the opening price is greater than yesterday's high price while A Full Gap Down occurs when the opening price is less than yesterday's low. A Partial Gap Up occurs when today's opening price is higher than yesterday's close, but not higher than yesterday's high while a Partial Gap Down occurs when the opening price is below yesterday's close, but not below yesterday's low.


Each of the four types of gaps has a long and short trading signal, defining the eight gap trading strategies which are explained below:

1. If a stock's opening price is greater than yesterday's high, revisit the 1-minute chart after 10:30 am and set a long (buy) stop two ticks above the high achieved in the first hour of trading. (Note: A 'tick' is defined as the bid/ask spread, usually 1/8 to 1/4 point, depending on the stock.)

2. If the stock gaps up, but there is insufficient buying pressure to sustain the rise, the stock price will level or drop below the opening gap price. Traders can set similar entry signals for short positions as follows: If a stock's opening price is greater than yesterday's high, revisit the 1-minute chart after 10:30 am and set a short stop equal to two ticks below the low achieved in the first hour of trading.

3. Poor earnings, bad news, organizational changes and market influences can cause a stock's price to drop uncharacteristically. A full gap down occurs when the price is below not only the previous day's close, but the low of the day before as well. A stock whose price opens in a full gap down, then begins to climb immediately, is known as a "Dead Cat Bounce." If a stock's opening price is less than yesterday's low, set a long stop equal to two ticks more than yesterday's low.

4. If a stock's opening price is less than yesterday's low, revisit the 1-minute chart after 10:30 am and set a short stop equal to two ticks below the low achieved in the first hour of trading.

5. If a stock's opening price is greater than yesterday's close, but not greater than yesterday's high, the condition is considered a Partial Gap Up. The process for a long entry is the same for Full Gaps in that one revisits the 1-minute chart after 10:30 am and set a long (buy) stop two ticks above the high achieved in the first hour of trading.

6. The short trade process for a partial gap up is the same for Full Gaps in that one revisits the 1-minute chart after 10:30 am and sets a short stop two ticks below the low achieved in the first hour of trading.

7. If a stock's opening price is less than yesterday's close, revisit the 1 minute chart after 10:30 am and set a buy stop two ticks above the high achieved in the first hour of trading.

8. The short trade process for a partial gap down is the same for Full Gap Down in that one revisits the 1-minute chart after 10:30AM and sets a short stop two ticks below the low achieved in the first hour of trading.

It is to be noted that Partial gaps are difficult to trade than Full gaps and once a stock has started to fill the gap, it will rarely stop, because there is often no immediate support or resistance.

To read more about gaps check out the following link from Investopedia: Gap Trading



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