moves higher still. A gap is formed between the two days prices; an empty space . A downward gap is when the security opens lower than the intra day low of the day before and continues lower intra day and for the close.
Gaps are usually points of very high or very low demand and will usually signal a continuation or follow through of the
security in the direction of the gap. They are excellent for catching security price moves. This is particularly true when you have other confirming indicators signalling movement in the same direction as the gap.
Gaps should also be accompanied by a relatively high volume, but nothing is guaranteed in technical analysis. At some time
prices will also generally move back into the area of the gap; this is known as filling the gap. This follows along with trader's
remorse which was discussed in an earlier edition.
If, while filling the gap, prices remain on the side of the break out and trade on lower volume you may infer the gap is
signalling the price of the security will follow through in the direction of the gap. Gaps do fail from time to time so always be wary.
The particular area on the chart where the gap occurs is itself a signal. The first area we will discuss is called the breakaway
gap. This gap occurs at the end of a move in the security and is in the opposite direction of the previous trend.
It signals the end of the previous trend as prices start to reverse. This type of gap is also one of the easiest to identify. It can occur in either direction; at a top with a gap down signalling an end of the up move and a correction coming or at a bottom with a gap up. This signals an end of the correction and a new trend forming with prices heading higher.
The second type of gap is the exhaustion gap which also occurs at the end of a move or trend. Unlike the breakaway, the exhaustion gap will be a gap in the same direction as the primary trend.
Watch the volume on the next few days trading if it fills the gap and look for a failure or break down of the gap itself as prices move further opposite of the gap direction. Quite often with exhaustion gaps prices will never fill the gap. The exhaustion gap is a signal that the security is close to ending its move and a change of trend is eminent.
The most difficult to recognize and trade are called measured gaps. These occur near the middle of a trend move. They occur in the direction of the trend and it is initially difficult to determine if you are looking at a measured gap or an exhaustion type of gap.
The key with the measured gap is the follow through does not move back within the gap to fill it over the next several days
trading . In this situation, you would then feel fairly confidant you have a measured gap which has signalled the middle of the move and more price movement ahead in the direction of the gap.
Gaps are powerful moves in the markets and can give you fairly clear cut signals about how trading with that security will move in the near future. Use them with your other indicators and you can better trade some of the tops and bottoms which occur in all securities.
