What is a Gap?
A gap is simply an open space left on a chart between two candles, where no trading occurs in the middle. It is caused by a sharp move up or down caused by things like analysts recommendations, earnings reports, takeover rumors, and any other type of big market moving news.
We only consider gaps on daily charts to be of particular importance, though they could occur on any.
In the example below you can see that on the 22nd stock had a low price of $75.19. After the close that day they reported worse than expected earnings. In the morning the stock opened significantly lower, then traded up a bit (to the top of the wick—line) to $72.96, before closing back near the low for the day. The space between one day’s low (or high), and the next day’s high (low) is a gap.
Note that gaps are measured between two consecutive days only, and between the wicks (high or low of the day), not the candle body.
Why does a gap matter?
Traders believe that all gaps must be filled. The question is always, when? In the above example you can see that for the next few days Target continued lower, leaving the gap unfilled. To fill the gap, the price of Target stock would need to return back up to $75.19. At that point, the gap would be filled by a candle, or multiple candles, covering that open space.
After bottoming out, Target began to climb, until on the 4th it closed the gap by trading through $75.19.
Here is another example:
This is a great example of why a gap is important to us. On June 20th Tesla announced that they were going to buy SolarCity. This news did not please investors, and they rushed to dump TSLA stock on the open that day. The stock opened about 9% lower that morning, then traded up and back down, but by the day’s end there was a big $12 gap left behind. The stock continued lower for a couple of days, but that gap was still sitting there tempting traders, and once the worst of the blowback from the news passed, the stock started climbing again.
Gaps can be used as support and resistance lines. Traders often tiptoe up to a gap fill, and then back off again. In this particular example you can see on July 1st the stock put in a big green candle that came very close to filling the gap, then pulled back for a couple days after finding resistance there. On July 7th it came within .69 cents of filling before pulling back at the close once again. Finally, on July 8th, TSLA stock popped through.
It’s important to remember that gaps don’t have a time limit on them. Some gaps fill in a day, some in a week, and some in a year. Here’s another gap caused by earnings. Earnings announcements very often cause gap moves in a stock’s price. In this case, Facebook shot up on good earnings and outlook. So far, as of this writing, it’s hardly looked back.
Gaps Recap:
Gaps can be found on just about any chart, and traders won’t forget they are there. A stock might trade away from a gap for weeks, months, even years, but at some point they always seem to return to get filled. When they get close you can bet that there will be at least some effort by traders to get it through there for a fill. It might take testing it a few times, like in the TSLA example above, but eventually they tend to punch it through.
So, watch for gaps, and take note of where they are when you are trading a stock, or just looking at a chart for support/resistance lines. They’re a handy waypoint for your stock to gravitate towards.