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3 Types of Gaps You Must Not Confuse

3 Types of Gaps You Must Not Confuse
February 01
09:48 2011

Sometimes traders get confused when they see a gap on a chart, and are not sure how to interpret it.That’s because there are three basic types of gap, and each has different characteristics.

Gaps are spaces in a price chart where no trading has taken place. You may for instance see a “gap open”, which means the first trades of the day start at a totally different price from the last trading session. It’s often said that “Gaps are always filled”, meaning that the price will come back to trade at the prices it has missed, but that’s just not true –it depends totally on what type of gap it is, and that stems from what made the gap in the first place.

The usual interpretation is that a gap to the upside, a jump in price, is a strong indication, and that a gap downwards is weak. If you think about it, that’s just the opposite of the trading saying given above, which seems to suggest that the price will meander back before long. Not surprisingly, that might have confused you. The answer is that there are three types of gap, and the interpretation of each is not the same.

The breakaway gap is seen at the end of a price pattern, and is a strong kick in the reverse direction signalling the beginning of a new trend. You will see heavy volume confirming the reversal, and it’s very unlikely that the price will retrace to fill this gap any time soon, it’s too strong a move. You can see this sometimes when the stock has been in a range, and it breaks out to start a new trend.

The opposite of this is called an exhaustion gap, and this is the type of gap which will probably be filled. As you can tell from the name, this is a kind of last gasp push at the end of a trend, and is often followed by a reversal. Definitely not a strong indication, and you can look for a close below the gap to confirm that it was an exhaustion gap and that the trend is finished. This is usually taken as a strong bearish signal.

I said there were three types of gap, and the third one is, quite literally, inbetween the other two, the breakaway gap and the exhaustion gap. This gap is called the runaway gap, or sometimes referred to as a measuring gap.

The runaway gap occurs in a good strong trend, but while the trend is running, not at the start like the breakaway gap. It shows fluid motion of the trend, and is an indication that the trend has a distance to run yet. Unlike the exhaustion gap, you will see strong supporting volume for the move.

As for the alternative name, the measuring gap, this is because some analysts think that it provides a measure of how far the trend will continue. It’s been observed that the runaway gap is usually around the middle of the move, and you can reckon that the trend has as far to run as it has already covered. However, you can sometimes get several breakaway gaps in a move.

Those are the three categories of gap that you will find. Next time you see a gap, be sure to think about what type it is and what it may be telling you about the price.

1 Comment

  1. Roxy Crisostomo
    Roxy Crisostomo June 15, 17:11

    Intriguing trading site. Will be back

    Reply to this comment

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