Trading Gaps: Strategies for Day Traders

In the fast-paced world of day trading, being able to understand and exploit trading gaps is a vital skill. This article will delve into the world of trading gaps, providing you with strategies to help you navigate this complex area successfully.

Understanding Trading Gaps

First, let’s define what we mean by ‘trading gaps’. A gap is a break between prices on a chart that occurs when the price of a stock makes a sharp move up or down with no trading occurring in between. Gaps can be created by factors such as regular buying or selling pressure, earnings announcements, a change in an analyst’s outlook or any other type of news release.

Types of Gaps

1. Common Gaps: These occur regularly and are usually filled quickly.
2. Breakaway Gaps: These are seen at the start of a new trend, often accompanied by high volume.
3. Runaway Gaps: Also known as continuation gaps, they signal a continuation of the prevailing trend.
4. Exhaustion Gaps: These are found near the end of a price pattern and signal a final attempt to hit new highs or lows.

Strategies for Trading Gaps

Successful gap trading requires a disciplined approach and the implementation of sound strategies. Here are some time-tested techniques:

Gap and Go Strategy

This strategy involves buying stocks with a gap up at the market open and selling them quickly after the gap is filled.

Fading the Gap

Fading the gap involves short selling stocks that have gapped up at the open and buying them back after the gap is filled.

Gap Fill Strategy

In this strategy, traders wait for the price to return to the original pre-gap level before entering a position.

Gap trading can be a highly profitable strategy when executed correctly. However, it’s not without risk, and traders should always use stop-loss orders to protect against potential losses.

Conclusion

Trading gaps can offer significant profit potential for day traders. By understanding the different types of gaps and implementing proven strategies, you can take advantage of these opportunities in the market. Remember, though, always trade responsibly and manage your risk carefully.