Gap Trading Strategies

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GAP Trading Strategies

In this article, I am going to discuss How to Day Trade with 5 simple GAP Trading Strategies. Please read our previous article, where we discussed VWAP Trading Strategy in detail. At the end of this article, you will understand the following pointers in detail.

1. What are the gaps?
2. Why the price gap?
3. 5 simple day trading gap strategy

What is Gap Trading Strategy?

The difference between two consecutive candles’ closing price and opening price is called the gap. A gap occurs when prices skip between two trading periods, skipping over certain prices. A gap creates a void on a price chart. Price gaps are simply areas on the chart where no trading has taken place.

Why do prices gap up?

• Gaps Greatest imbalance between demand and supply. The gap is up because of aggressiveness by buyers, I mean there are more buy orders at the open than there is available supply at the prior day’s closing price. The gap is down because of the aggressiveness of the sellers, I mean there are more sell orders at the open than willing demand at the prior day’s close. Therefore, gaps are almost always at price levels where there is a supply and demand imbalance at the open.
• Gaps also occur due to the overnight sentiment of the participant or any big news
• Smart money trying to skip important support and resistance level, i.e. If they are bullish they gap-up price above the supply zone

GAP act as Support and Resistance

The Up gap act as a support zone and the down gap act as a resistance zone. The chart below of RELIANCE stock shows the gap up acting as support for prices. 

The Gap fill

The gap-fill refers to the price retrace and close the level where the origin of the gap occurs. The closure rate (gap-fill) for up gaps increases if the prior day’s open-to-close price trend was also up. The closure rate (gap-fill) for down gaps increases if the prior day’s open to close move was downward.

After the gap price tries to fill the gap. Another occurrence with gaps is that once gaps are filled by price, the gap tends to reverse direction and continue its way in the direction of the gap (for example, in the chart BELOW of RELIANCE, back upwards).

Types of Gap Trading Strategy

Gaps are divided based on the context in which they appear.

1. Breakaway (or Breakout) Gaps
2. Runaway (or Measuring) Gaps
3. Exhaustion Gaps
4. Professional gap
5. Inside gap

What is the breakaway GAP?

The breakaway gap means breaking the important support or resistance or significant trend line in the form of the gap. Generally appears after completion of important patterns like price in consolidation range or any continuation or reversal pattern. Maximum time this gap does not fill quickly or on the same day. The most important volume should be high

Why does the breakaway gap occur?

The smart money knows exactly where these resistance areas are. If the smart money is bullish, and higher prices are anticipated, the smart money will certainly want a rally. The problem now is how to avoid the old resistance

• Gapping up through an old area of supply as quickly as possible is an old and trusted method – a way of avoiding resistance.

We now have a clear sign of strength. Smart money does not want to have to buy the stock at high prices. They are already bought their main holding at lower levels.

Smart money knows that a breakout above an old trading resistance area will create a new wave of buying. How?

• Many traders who have shorted the market will now be forced to cover their poor positions by buying as well.
• Many traders are looking for breakouts will buy.
• All those traders who are not in the market may feel they are missing out and will be encouraged to start buying.

Here you can see that prices have been quickly up moved by smart money, whose opinion of the market at that moment is bullish. We know this because the volume has increased. It cannot be a trap-up move, because the high volume is supporting the move

The chart study above shows breakaway gaps through important support and resistance levels. Every breakaway gap leads to a trend continuation as well.

Runaway (or Measuring) Gap:

After the move has been underway for a while, somewhere around the middle of the move, prices will gap, this gap is called the runaway gap. In an uptrend, it’s a sign of continuation of a trend; in a downtrend, a sign of continuation of the trend.

Exhaustion Gap:

You will find that weak gap-ups are always Gap up to resistance or gap down to support. This price action is usually designed to trap you into a potentially weak market and into a poor trade, catching stop-losses on the short side, and generally panicking traders to do the wrong thing.

Near the end of an uptrend, the exhaustion gap occurred. However, that upward gap quickly fades and prices turn lower. When prices close under that last gap (exhaustion gap), it is usually a dead giveaway that the exhaustion gap has made its appearance. An exhaustion gap occurs with extremely high volume. 

Professional GAP Trading Strategy:

These gaps appear at the beginning of the moves. Generally occur at the supply or demand zone. (Gap up from demand zone and gap down from supply zone) when price approaches the quality supply and demand zone

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Inside GAP Trading Strategy

Inside gaps are gaps happening inside the prior day’s range.

1. Week market gap up
2. Strong market gap down

However, low volume warns you of a trap up-move (which is indicative of a lack of demand in the market) after a gap up resistance

Gap Trading Strategy:

There are three factors to monitor to determine whether the gap is real or trapped. The three factors are volume, opening price, and pullback

Opening Price and Pullback

After a gap up, the pullback to be watched

• Flat pullback (price consolidates high of the day). Strong buy signal
• The weak pullback was unable to close below the previous day’s high. buy signal
• Strong pullback closes below the previous day’s high. sell signal

If the stock gaps up and then sell off and remains beneath its opening price after the morning pullback has stabilized, it’s possible that the stock has reached its high of the day. however, if a stock gaps up and pulls back during the morning pullback, but then rallies to break above its opening price, the mark-up was probably not trapped gap and the stock should make new intraday highs

Volume

• It is important to watch the volume carefully when determining if a gap is valid. If the stock gap up high and the volume is also high and also the price remains above its opening price after the early morning pullback, it is an excellent sign that the stock has further to go on the upside. All reverse for a trap gap up
• If high volume appears after a gap up and the stock immediately comes under selling pressure, chances are that this volume was a seller
• If a large volume of paper in a gap up the situation and if the stock runs higher, then chances are that it was a buyer, probably the reason for the gap up in the first place. The smart money will support the stock if he has the buyer, or he will sell stock in a hurry if he has the sellers. Smart money does not generally chase the stock in the direction of the gap in the early morning unless there is a fundamental reason for doing so

Our entry is based on two types of gap

1. Outside gap(market open outside of the previous day range)
2. Inside gap(market open inside of the previous day range)

Outside gap

1. Gap and GO Trading Strategy

All gaps are not filled in that day

Gap and GO Trading Strategy criteria

1. Price gap up above previous day’s high
2. Wait for the first candle to complete
3. Volume should be high and supporting in the direction of the gap
4. Mark opening range
5. Entry on breakout of high of the day
6. Price should above vwap

2. Gap-fill reversal Trading Strategy

When a market gaps up, then the gap act as a support level for any pullback. Pullback Tests of gaps on lighter volume tell that the issue does not have enough energy to get through the gap; instead, the gap becomes support and any bullish signal is triggered by our buy entry

1. Wait for the price gap up
2. Wait for a stock to pull back to its prior day’s close and fill the gap.

Two types of Pullback

1. Price gap up just above the previous day’s high or below the previous day’s low, and then a strong pin bar formed which fill the gap. volume should be high on the pin bar
2. Second price gap up and then retrace and fill the gap. it takes more than 2 candles and the volume should be decreasing
3. You then wait to see a sign of strength and enter the position on that move.
4. Price should not close inside the previous day in any five-minute candle
5. You then place a stop below the low of the candlestick.

3. Open Gap Reversal Trading Strategy

These patterns generally appear at the top or bottom or any strong supply or demand zone

The open gap reversal process

1. There needs to be an existing extended uptrend on the chart for at least a few trading sessions to the supply zone. A gap up in price to quality supply zone is a VERY high odds shorting opportunity.
2. Or a gap up in price to quality supply zone in the context of a downtrend is a VERY high odds shorting opportunity.
3. After a gap up the price starts falling and crosses yesterdays. This generates the sell
4. The Stop-Loss is the low of the same day.

NOTE:-As we are trading against the gap more confirmation is required confirmation either from price action or volume action

4 & 5. Inside GAP Trading Strategy

Let’s analyze a downtrend and the previous day was a down day. Today’s price gap is up but close within the range of the previous day. Our entry opportunity will be

• Gap up short
• Gap up long

A gap up in price, in the context of a downtrend, is a VERY high odds shorting opportunity if any bearish reversal signal is given. A gap up in price, in the context of a downtrend, is a lower odds buying opportunity

If the stock gaps up and then sell off and remains beneath its opening price after the morning pullback has stabilized, it’s possible that the stock has reached its high of the day. however, if a stock gaps up and pulls back during the morning pullback, but then rallies to break above its opening price, the mark-up was probably not trapped gap and the stock should make new intraday highs

In an uptrend, entry opportunities will be

1. Gap down long
2. Gap down short

Gap up short in a downtrend 

• Context downtrend
• Wait for at least 5 minutes. Or mark the opening range
• After the 5 minutes, wait for a reversal price signal to provide you with short-term confirmation that the mark-up was a trap by smart money and the short-term trend is pointing downward.
• Then short below of the first candle
• Volume should be below. If the stock has gapped up high; volume should be high for confirmation of the real gap. However, if the price closes below the opening price with no large volume, chances are that the mark-up was a trap by smart money

Let’s analyze the gap down long in an uptrend

Gap up long in a downtrend

How to know, whether the gap up is real or trapped by smart money

• Market when gap up opening, the volume should be heavy to go higher. if smart money is active supported by volume
• Wait and see if the market trades above its opening prices after the morning pullback. It indicates the gap was real
• Then go long
• Or you can enter from a previous day’s low when the price retrace test of the previous day’s low

Note: – This entry technique is very risky as we are going against the trend and momentums so double confirmation is required

It is very useful for this trading strategy if you combine our Pullback Trading Strategy and the Advance CANDLESTICK Analysis article.

In the next article, I am going to discuss Intraday Open High Open Low Trading Strategy in detail. Here, in this article, I try to explain, How to Day Trade with GAP Trading Strategies in detail and I hope you enjoy this GAP Trading Strategy article. Please join my Telegram Channel and YouTube Channel as well as my Facebook Group to learn more and clear your doubts.