How To Trade Gap Fill Stocks

Most investors are familiar with the sort of fundamental analysis commonly used in choosing which stocks to buy. It is the practice of examining a variety of factors, including financial performance, the effectiveness of a company’s management, and the economic environment, to determine whether shares are priced correctly based on the company’s intrinsic value. 

In many cases, investors using a fundamental analysis approach attempt to predict whether and when stock prices will rise or fall based on prospects for future growth, and they make trading decisions accordingly. 

While fundamental analysis of stocks gets lots of media attention, many investors rely on another analysis method altogether. Rather than evaluating the fundamentals, these investors use technical analysis to predict future share prices. At its most basic, technical analysis involves collecting and organizing historical data to pinpoint patterns and predict price trends. 

Investors who make trading decisions based on technical analysis employ a long list of strategies to determine when to buy and sell. One of these strategies involves “playing the gap” or trading gap fill stocks. The concept is surprisingly simple, though successful execution can be tricky. Nonetheless, many investors have succeeded in generating strong returns with gap fill stocks. 

What is a Gap? 

Stock price charts illustrate price movements over time. The x-axis shows the trading period, and the y-axis shows the price at which the stock is trading. Through this illustration, patterns are visible, and there are signals that indicate what stock prices might do next. Technical analysts know how to act on these signals to buy and sell at the right time to make a profit. 

Anomalies in stock price behavior are of particular interest to investors. They tend to be followed by very predictable price movements, and those who know what these movements are likely to be have an opportunity to act. Gaps are an example of unusual behavior that can present an opportunity for profit. 

The pricing information on a stock chart tends to show continuity, even when prices are highly volatile. There is a connection between the close of the previous trading period and the opening of a new trading period. When the price at the close of the previous trading period and the opening of a new one is so different that the two points on the chart aren’t connected, it is referred to as a gap. 

The most common example of a gap occurs when something dramatic happens between the time the market closes and the time it reopens. Investor sentiment shifts overnight, and an influx of buy or sell orders come in. This causes the stock’s price to open much higher or lower than it closed the previous period. On a chart, there is a well-defined space or gap, which is how this phenomenon gets its name. 

Types of Gaps

There are four distinct categories of pricing gaps on stock price charts. The type of gap influences decisions around trading gap fill stocks. 

• Breakaway Gaps – When gaps occur at the end of a price pattern, they indicate the start of a new trend in share prices. 
• Exhaustion Gaps – Gaps that occur near the end of a price pattern, though not at the end, demonstrate that a stock is making a last attempt at reaching a new high or low. 
• Continuation Gaps or Runaway Gaps – These types of gaps are found in the middle of a price pattern. They indicate that there is a sudden change in sentiment, and many investors believe that a stock is about to go up or down. 
• Common Gaps – Unlike breakaway gaps, exhaustion gaps, and continuation gaps, common gaps don’t fall into a price pattern. They simply show a gap in pricing due to normal trading activity. 

Playing the gap by trading gap fill stocks relies on understanding and executing the appropriate transaction for the type of gap that has occurred. 

What Does It Mean To Fill A Gap In Stocks?

More often than not, gaps represent a temporary condition, and the stock price returns to its pre-gap level. In other words, the gap is filled.

In some cases, that happens because the influx of buyers or sellers rethinks their initial excitement or reconsiders their loss of confidence – or other investors see an opportunity in the unusually high or low prices, and they cause the stock price to correct. 

In other cases, gaps fill because there is technical resistance. The existing support or resistance thresholds are no longer valid due to the sudden increase or decrease in pricing. That situation is often unsustainable, causing the gap to fill. 

Finally, the type of gap may indicate whether it will be filled. Breakaway gaps confirm the direction of a pricing trend, so they may not be filled. Exhaustion gaps, on the other hand, come at the end of a pricing trend, so they are likely to be filled. 

Do All Stocks Fill Gaps?

The financial world is full of regularly repeated theories, proverbs, and maxims. One common saying is “all gaps are eventually filled.” While it is true that many – perhaps most – gaps are filled, all stocks do not fill gaps. 

Rather than trading on the assumption that all gaps will be filled, smart investors examine the type of gap. Common gaps occur for any number of reasons – or no reason at all – and they are nearly always filled. These sorts of gaps rarely impact the stock’s overall trend. 

Exhaustion gaps, which occur at the end of an extended trend, are very likely to be filled. These gaps tend to signal a reversal in the established trend, and they are marked by a wide gap between trading periods and a large increase in trading volume. 

Runaway gaps, sometimes referred to as measuring gaps, are usually filled at some point, but they are not filled right away. They can be seen during a trend that is already well-established, and they often occur when company-related news prompts positive or negative interest in the stock. 

Breakaway gaps, which essentially confirm the direction of an established trend, are the least likely to be filled – and the most likely to cause losses when misidentified. Mistaking another type of gap for a breakaway gap nearly always results in executing the wrong strategy. 

It’s true that most stocks fill gaps, especially when they are upward gaps. However, not all stocks fill gaps, so it is critical to identify the type of gap and leverage additional data to select and execute a strategy that delivers positive returns. 

Why Do Stocks Need To Fill Gaps?

So, why do stocks need to fill gaps in the first place? It’s a fair question, especially for traders interested in playing the gaps. The short answer is this – stocks don’t necessarily need to fill gaps, but it happens more often than not. 

That’s because gaps are a brief response to changing conditions. When the immediate change has passed, or investors become accustomed to the new conditions, stock prices tend to settle back into their pre-gap state. 

Consider this: stock prices tend to move between levels of resistance and support. At the point of resistance, investors are simply not willing to pay more, and the price cannot break through. At the point of support, investors are willing to buy, preventing stock prices from dropping further. 

A sudden change in conditions, for example, a bit of good news, can prompt a flurry of activity which causes a gap. Once the initial enthusiasm has passed, and longer-term factors are added back into the equation, stock prices return to status quo and fill the gap.

How To Trade Gap Fill Stocks

In terms of how to trade gap fill stocks, the right strategy depends on the specific situation and the investor’s level of risk tolerance. Some strategies are more reliable than others, and those that have higher potential rewards carry more risk. 

One method of playing the gap is to attempt to predict upcoming gaps – particularly when price increases are likely. For example, companies often release their earnings reports after trading closes for the day. When those earnings reports show especially strong results, buying shares after hours can create instant profits in the event that there is a gap when trading opens the following day. 

Alternatively, traders may choose to play the gaps by buying or selling shares in the opposite direction once they believe a stock has hit its high point or low point. They typically make this determination using other methods of technical analysis. 

Finally, traders may choose to buy after the gap has been filled and the stock price hits its previous support level. Under such circumstances, share prices are likely to trend up. 

Key Points for Gap Fill Stocks Strategies

Trading gap fill stocks can be profitable for those with the experience and expertise to draw correct conclusions from the results of technical analysis. However, returns are not guaranteed, and there is risk in any strategy for trading gap fill stocks.

Keeping the following key points in mind will reduce the likelihood of a preventable error:

• When stocks begin to fill a gap, they tend to continue until the gap has been filled in its entirety. This occurs because there are no established post-gap support or resistance levels. 
• Continuation gaps and exhaustion gaps occur when price movements occur in opposite directions. Traders must take special care to identify the type of gap before taking a position. 
• Trading volume is a clear indicator of the type of gap occurring. Breakaway gaps generally come with high trading volume, while exhaustion gaps are marked by low trading volume. 
• Gaps caused by sudden optimism or pessimism are typically driven by retail investors. Institutional investors are rarely so excitable. However, it is not uncommon for institutional investors to join retail investors exhibiting “irrational exuberance” in buying or selling a stock simply because it is an opportunity to boost portfolio value. The takeaway for traders playing the gap is to proceed with caution when considering the behavior of institutional investors in trading decisions. Generally, it is wise to wait for the price to begin a break before making a move.

Before selecting and executing a gap fill strategy, it is critical to identify the type of gap correctly, as this makes accurate prediction of future behavior more likely. 

What Happens After A Gap Is Filled?

The period after a gap is filled can be profitable for traders who know how to take advantage of the situation. It is common to wait until share prices reach pre-gap support or resistance points, then buy or sell in the opposite direction. 

While it is possible that share prices will see new highs or lows after a gap has occurred and then filled, it is more likely that previous support and resistance levels will apply. Those who are carefully monitor trading activity and price changes can be successful in predicting when pricing will change direction with some degree of accuracy. 

How Do You Know If A Stock Will Gap Up?

There are no foolproof methods of predicting whether a stock will gap up because the market doesn’t always behave in a predictable manner. However, through careful analysis of historical activity, some traders have been able to make accurate projections on a regular basis. 

The biggest indicator of a possible gap is overnight news. The most common example is earnings report releases, but that’s not the only example. World events can also impact markets, and in some cases, they drive individual stocks up between the close of one trading period and the opening of another. 

Gap Fill Stocks Trading Takeaways

“Playing the gap” includes a collection of strategies intended to generate returns by predicting gaps, trading gap fill stocks, and/or using technical analysis to determine how stock prices will behave after a gap is filled. 

The most important takeaway for aspiring traders is that correctly identifying the type of gap is critical to success. Whether a gap will fill and how share prices will move after the gap has occurred is almost entirely dependent on the category of gap involved.

Common gaps, exhaustion gaps, and runaway gaps are generally filled, though the timing differs. Breakaway gaps are less likely to be filled, which means they require traders to adopt a different strategy in order to profit. 

Gap Fill Stocks: The Bottom Line

The bottom line is that gap fill stocks can generate strong returns for traders who complete the research required to accurately identify the type of gap that is occurring.

Gaps can confirm a trend or signal its reversal. In some cases, they do neither – they are just a brief incongruity in an otherwise stable stock. As with any investment strategy, returns are not guaranteed, and losses may occur. 

---

The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.