How To Identify Stocks Gaps Properly? (The 4 Gap Types)

What is a Gap in Stocks?

Gaps refer to upward or downward price graph cut-offs. Although many might know what gaps are, the psychology behind them and the information they send is less known.

“Prices move in cycles of Yin and Yang,” said Munehisa Honma (1724-1803), also known as the God of Markets. People have different opinions about the price regardless of the market’s trend.  A gap forms when most market participants have the same opinion and motivation to buy or sell the asset with large enough capital.

You can rarely find gaps in forex or commodity markets, and almost never in cryptocurrencies. Unlike the mentioned markets, daily stock market charts form the most gaps. Therefore, they are better practice ranges for beginners to find price chart gaps. The motivation for such large market movements can either be technical or fundamental.

Technical reasons can be the majority of people entering or leaving the market based on the same technical analysis result. As for fundamental motivations, news of a war or an epidemic like COVID-19, an interest rate hike or drop, or asset-related news, in general, can initiate such movements resulting in a gap or a series of gaps in the price chart.

In contrast to how significant it might sound, most gaps get filled with no major effect on the asset price. But what do I mean by a gap “fill”? How does a gap get filled? What does it mean for the price? Before visiting the gap types exhibit, I’ll let you find the answer in the following part.

What is a Gap Fill in Stocks?

Gap fills occur in almost all markets (except the crypto market), not just in the stock market. Gap fills can be described in two ways only: bullish or bearish. This section will teach you about gap fills and what data each sends.

Gaps are not rare events. In fact, they form all the time. When a gap is born on a price chart, the price can not go back in time and fill or close the gap. The gap stays on the chart forever. A gap fill happens when future candles form in the same price range as the gap.

The majority of gaps get filled unless they form around All Time High/Low (ATH/L) of an asset price because the price may never hit that price ever again. The gap fill time also matters; some gap fills happen immediately after the gap with the next following candlesticks.

On the other hand, some gap fills take time. A gap might take days, months, or even years to fill. In such a case, the gap fill doesn’t matter anymore, since everyone who noticed it has forgotten about it.

It is interesting to know that when Bitcoin was initially listed as a stock in Chicago Mercantile Exchange (CME), its price chart formed gaps, most of which were filled afterward. I suggest you investigate more in my article about the Bitcoin roadmap. Now that we know enough about gaps and how they get filled, It is time to visit the promised gap types of exhibits.

 

What are gap types in stocks?

Gaps are either upward or downward. They are addressed as “gap ups” and “gap downs”. Gap names do not provide new information apart from the gaps’ direction. This section will teach you about all gap types and what data you can mine from each.

Next, we’ll examine four gap types and what they mean when you find them on the price chart. Let’s begin the list with the most common type of gap: the Common gap.

Common gap

This type is the most common among all four, as the name suggests. Common gaps form in both upward and downward directions.  These gaps form on charts even without major news or predictable events or movements. As with fundamental factors, there are few to no technical factors backing up Common gaps.

For example, you won’t see much volume increase (if any) backing the Common gaps. Because technical and fundamental factors do not back a Common gap, the following candles fill the gap soon after its birth. Now that you know about Common gaps, let’s move on to some gap types that are less common.

 

Runaway gaps 

Unlike Common gaps, Runaway gaps are backed by high trading volume. A Runaway gap forms when the price is in such a strong upward/downward trend that the price jumps up/drops down and forms a gap between candles.

It might be hard to identify Runaway gaps at first. How can you separate it from Common gaps?

Runaway gaps are backed by tall red or green columns of trading volume, but Common gaps are not. You must see a rise in the trading volume regardless of the Runaway gap direction. High trading volume is key to finding Runaway gaps.

Whenever a Runaway gap forms in a chart, the price will likely continue trending in the gap direction. For example, if a Runaway gap forms in an upward trend, the upward movement is expected to continue. Therefore, Runaway gaps are also known as Continuation gaps.

Also, Runaway gaps mostly form in the middle of a trending market, plus when continuation patterns (such as Ascending/Descending Triangle and Long Island) take effect.

Don’t worry if you are unfamiliar with these patterns; I will discuss them in detail in future articles.

No matter how strong the trend is, major support and resistance levels sometimes prevent the price from moving further down/up.

The next gap type has the power to shatter support and resistance levels.

Breakaway gaps

As with Runaway gaps, Breakaway gaps are also backed by high trading volume. The Breakaway gaps form when a gap breaks an important zone, such as support/resistance zones or trendlines. When an asset is being traded in an established range, and a gap kicks the candles outside the range borders, that gap is a Breakaway gap.

Breakaway gaps also tend to start strong market trends. Therefore, they are associated with valid and reliable market reversals. Breakaway gaps can also be combined with classic patterns such as Triangles, Wedges, Cup and Handle, Rounded top/bottom, Head and Shoulder pattern, etc. A Breakaway gap basically confirms the reversal patterns’ validity.

I will discuss classic patterns in future articles, so stay tuned. Seeing a high trading volume with the Breakaway gap means that the price will likely trend in the Breakaway gap direction.

Sometimes gaps can’t break support/resistance levels. Instead, the gap respects the important price level and begins a market reversal.

I hope you’ve saved energy for the last item on the menu, the Exhaustion gap.

Exhaustion gaps

The Exhaustion gap is unlike any other gap in the gaps family; although it is not a Common gap, it demands lower than average trading volume. These gaps form either before a market reversal or start one. When the price stays upward or downward for a while, the trend reaches its final days; as Dr. Nirvadha Singh stated, “Everything in this world has an expiry, some sooner than others.”

In the upward trend of the last few days, the price has gone so high that most bulls don’t want to buy anymore. On the other hand, sellers click the “sell” button confidently.  Buyers’ last push might cause the price chart to gap up with insignificant trading volume before pivoting soon later.

If the gap’s following candles form candlestick patterns like Doji Shooting Star or Three Black Crows, it increases the chance of a reversal. As for downward trend Exhaustion gaps, you just have to reverse everything I said about upward trend exhaustion gaps.

Remember that the Exhaustion gaps are expected to get filled shortly after they form. The Exhaustion gaps getting filled, plus low trading volume, is how you can separate them from Breakaway gaps.