Swing Trading Gaps

How to trade gaps on a stock chart

Are all gaps created equal? Nope. There are really only two significant factors to consider when trading gaps.

You have to be able to identify if the gap is caused by professional traders or amateur traders. There is a big difference between the two!

Wait a minute...let's back up a second...

What is a gap?

A gap is defined as a price level on a chart where no trading occurred. These can occur in all time frames but, for swing trading, we are mostly concerned with the daily

chart. A gap on a daily chart happens when the stock closes at one price but opens the following day at a different price. Why would this happen? This happens because buy or

sell orders are placed before the open that cause the price to open higher or lower than the previous day's close.

Here is an example:

Let's say that on Tuesday, Microsoft closes at $26.57. After the close they come out

with their earnings report. They report higher than expect earnings that causes excitement among investors. Buy orders come flooding in. The next day Microsoft opens

at $27.60. Since there were no trades between $26.57 and $27.60 this will create a gap on the chart.

Let's look at a chart:

 

        

You can see on the chart above that the stock closed at one price and then the next day the stock "gapped up" creating a price void on the chart (yellow circle).

 

Sometimes you will hear traders say that a stock is "filling a gap" or they might say that a stock has "a gap to fill".

Are you wondering what the heck they are talking about?

They are talking about a stock that has traded at the price level of a previous gap. Here is a chart example:

 

       

 

Swing Trading Gaps

How to trade gaps on a stock chart

Are all gaps created equal? Nope. There are really only two significant factors to consider when trading gaps.

You have to be able to identify if the gap is caused by professional traders or amateur traders. There is a big difference between the two!

Wait a minute...let's back up a second...

What is a gap?

A gap is defined as a price level on a chart where no trading occurred. These can occur in all time frames but, for swing trading, we are mostly concerned with the daily

chart. A gap on a daily chart happens when the stock closes at one price but opens the following day at a different price. Why would this happen? This happens because buy or

sell orders are placed before the open that cause the price to open higher or lower than the previous day's close.

Here is an example:

Let's say that on Tuesday, Microsoft closes at $26.57. After the close they come out

with their earnings report. They report higher than expect earnings that causes excitement among investors. Buy orders come flooding in. The next day Microsoft opens

at $27.60. Since there were no trades between $26.57 and $27.60 this will create a gap on the chart.

Let's look at a chart:

        

see how this stock gapped up after a wave of buying occurred? These amateur traders got emotionally involved in the stock. They piled in after an already extended

move to the upside.

 

These traders eventually lost money as the stock sold off over the next few weeks. Notice how the stock eventually did go back up - but only after a wave of selling

occurred (professional buying).

 

Here is another chart:

       

See how this stock gapped down after a wave of selling occurred? These amateur traders got emotionally involved in the stock. They sold after an already extended

move to the downside

Ok, so let's break this down, shall we?

If a stock gaps up after a wave of buying has already occurred, these are amateurs buying the stock - look to short. If a stock gaps down after a wave of selling has

already occurred, these are amateurs selling the stock - look to go long

These types of gap plays usually provide great opportunities because they represent and extreme price move

Well, there you have it...a short primer on trading gaps.

Gaps can provide nice swing trading profits but they can be a little more tricky to trade. The advantage is that you can sometimes make big profits, quickly, and with

a little less risk...