Trading Stock Gaps

  A price gap is an area on a chart where no trading has taken place. There can be gaps in an uptrend when the prices open above the previous day's highest price and that space is not filled during the day. In a downtrend, the highest price of the day is below the previous day's low. Upside gaps signify market strength, whereas, downside gaps show weakness. Although gaps are mostly seen on a daily bar chart, which is very significant to a trader who is Day trading, they do appear on weekly and monthly charts and are very significant then to Swing and Options traders.
  One of the biggest myths associated with the interpretation of gaps is that "gaps are always filled". Not true; some gaps should be filled and some should not. Le me also add, depending on which of the three types of gaps it is, breakaway, runaway or exhaustion, the gap will have different forecasting implications. Experienced traders are likely familiar with the term "filling the gap" but it's a term worth reviewing. If a stock moves against you, gapping open sharply higher or lower (as a result, for example, of earnings from a "sympathy stock"), consider removing stop orders momentarily and watching the trade very closely. Many times shares will reverse from the extremes of the gap, moving back toward the previous day's closing price, before setting a clear direction for the day.
  Opening price gaps can be up or down, and the size of the gap often has an impact on subsequent price activity. For example, if a gap is relatively wide, many traders will enter positions in the opposite direction of the gap - a tactic called "fading the gap."

  Each stock  gap types has a long and short trading signal, defining the eight gap trading strategies. The basic tenet of gap trading is to allow one hour after the market opens for the stock price to establish its range. A Modified Trading Method, to be discussed later, can be used with any of the eight primary strategies to trigger trades before the first hour, although it involves more risk. Once a position is entered, you calculate and set an 8% trailing stop to exit a long position, and a 4% trailing stop to exit a short position. A trailing stop is simply an exit threshold that follows the rising price or falling price in the case of short positions.
Breakaway gap is a significant development and has strong implications in the direction of the gap for the stock. Breakaway gaps occur when prices jump outside of a recent trading range or consolidation area. This may happen when a stock opens well above any high made recently or well below any low made recently, as a result of sudden extreme optimism or pessimism. Breakaway gaps are not filled quickly, and leave a blank space on the stock chart. Breakaway gaps often occur as resolutions to common chart patterns, as traders identify a pattern and rush to be the first into the trade. Identifying breakaway gaps properly can lead to very reliable trading signals, particularly when they occur on high volume.

  What causes gaps? Usually it is news driven. Individual stocks can gap up or down due to news such as earnings reports, earnings pre-announcements, analyst's upgrades and downgrades, rumors, message board posts, key people in the company commenting, buying or selling the stock.