Top Tips On How To Trade Gaps

A gap is an empty space on a price chart between two candles that are next to each other.

Gaps happen when the next candlestick opens at a distance from the price of the previous candlestick. A sudden surge of buy or sell orders may happen if the market quickly changes its view of the price. At some point, the price of an asset at the end of a candlestick is no longer important to traders. Instead, the new price of the next candlestick better reflects the value of an asset (a currency pair).

"Window" is a term used in Japanese technical analysis to refer to gaps.

These are the three main types of gaps:

1.  Continuity gaps.

A gap in the middle of a price pattern means that a lot of people think the price will keep going in the same direction. A bullish gap in the price chart means that the uptrend is going to keep going. There is a bearish gap if a trend is bearish and the gap is bigger than the trend.

Below, you can see a chart of Apple that shows an example Continuity gap.

Continuation gap

2. Breakaway gaps

When a price pattern comes to an end, breakaway gaps appear. They show that a new trend is about to start. A gap like this happens when the price is trying to reach a level on the chart. This could be support or resistance on the chart. It could also be the trend line or channel that the price is following. 

Suddenly, the price breaks through the level that had been tested. Then, it starts a new trend that goes in the direction of the break. On the chart, it is easy to see gaps that break away. It is also good because a trader can join a new trend right away when they spot a gap in the market.

On the chart of Tesla, you can see an example of a gap that has broken away. The news that Tesla would be added to the S&P 500 caused that rise.

Breakaway gaps

Note: breakaway gaps happen after important news reports.

Also Read: How To Trade With Chart Patterns

3. Exhaustion Gaps

Exhaustion gaps occur at the conclusion of a price pattern and indicate a last effort to make new highs or lows. During this period, the last trend of market participants joins the trend, and there will be no one to support it after that. As a consequence, an exhaustion gap is followed by a price reversal.

 It is feasible to substitute an exhaustion gap for a continuation gap. To differentiate between these two kinds of gaps, look at the size of the candlesticks: if a currency pair is particularly volatile, the candlesticks on the chart are large, and the price has made multiple jerking changes, it might be an exhaustion gap.

 Exhaustion gaps

On Facebook's chart, you can see exhaustion gaps. There was no one to support the continuation of an uptrend after the recent leap, therefore the stock reverted down.