Gap Theory: Types and Trading
Understand the four types of price gaps, how they interact with candlestick patterns, and strategies for each type.
Gap Theory: Types and Trading
A price gap occurs when the market opens significantly above or below the previous close. Gaps carry significant implications for pattern traders.
The Four Types of Gaps
Common Gaps: Occur in sideways markets, carry no technical meaning. Typically small and filled quickly. Trading noise.
Breakaway Gaps: Price gaps out of a consolidation zone. Signal the beginning of a new trend. High volume, often remain unfilled for a long time.
Runaway Gaps (Measuring Gaps): Occur mid-trend as the trend accelerates. Signal intensifying momentum. Often occur about halfway through the total move.
Exhaustion Gaps: Occur near the end of a trend -- the final burst of buying or selling. Followed by rapid reversal and quick fill.
Gaps and Candlestick Patterns
Gap-enhanced patterns: Morning/evening stars are stronger with gaps between candles. The abandoned baby requires gaps on both sides.
Post-gap patterns: A gap up followed by a bearish candle suggests exhaustion. A gap up followed by bullish confirms breakaway/runaway.
Gap-fill patterns: When price fills a gap, a bullish pattern at the gap fill level suggests the gap level is now support.
Trading Breakaway Gaps
Trading Exhaustion Gaps
Gap Fill Statistics
Common gaps: fill within 1-3 sessions. Breakaway gaps: may not fill for weeks/months. Runaway gaps: often partially fill during pullbacks. Exhaustion gaps: fill quickly, usually within days.
The Island Reversal
Cluster of candles isolated by gaps on both sides. Rare but highly reliable reversal signal.
> Key Takeaway: Gaps reveal sudden supply-demand imbalances. Breakaway gaps launch trends; exhaustion gaps end them. The candle that forms after a gap tells you which type you have.