From time to time gaps will appear on price charts, when the market jumps over certain price levels in the series. These gaps are typically caused by some outside event that isn’t directly related to trading or the market. There are several events that can cause price gaps on graphs, with the most common being surprise news, or weekend market closure. There are three types of gaps:
- Breakaway Gap. These appear at the beginning of a strong upward or downward trend, and represent very high-volume trading.
- Runaway Gap. These occur during an upward or downward trend, and represent a quick momentary intensification of that trend. This is the most commonly seen gap.
- Exhaustion Gap. This occurs toward the end of an upward or downward trend, and tends to indicate a small trend in the opposite direction. Exhaustion gaps can be difficult to identify, but also very profitable when they are correctly identified.
One common feature of gaps is that they are almost always closed by price retracing the open area on the graph. While this I useful to know, it can sometimes be misleading as the closing of the gap doesn’t need to occur immediately, but could take weeks or even months before it happens.