Author: Doumkou Stefani
Publication date: 04.10.2024
Gaps in trading happen when prices jump up or down suddenly, offering chances to make quick profits. In this article, we explore four effective trading strategies tailored for the four basic types of gaps: common, breakaway, runaway, and exhaustion gaps.
Common Gaps Strategy
Common gaps are small and usually fill quickly, meaning the price often returns to the pre-gap level within a short period. If a stock opens with a gap up (price higher than the previous close) without significant news, you could short the stock (bet that the price will go down) and profit when the price drops back to the previous close. Conversely, if a stock gaps down (price lower than the previous close), you could buy, expecting the price to rise to fill the gap.
Key elements of the common gap strategy include identifying a gap that typically occurs within a trading range, usually without strong volume and a stop loss is set around the gap, expecting the gap to fill quickly, with limited long-term price movement.
Breakaway Gaps Strategy
Breakaway gaps signal the start of a new trend, and you can profit by trading in the direction of the gap. When you spot a breakaway gap, enter a trade in the direction of the gap (buy if it gaps up, sell/short if it gaps down). These gaps are less likely to fill quickly and often indicate strong momentum.
Key elements of the breakaway gap strategy include identifying a gap at key support/resistance levels, confirming with high volume and a stop loss is set just beyond or (below the gap depending on the trend). The target price is also set based on the gap size or next technical level.
Runaway Gaps Strategy
Runaway gaps suggest the continuation of an existing trend, so trading in the direction of the gap can be profitable. Enter a trade in the same direction as the ongoing trend. Since runaway gaps usually occur during strong trends, you can ride the trend until signs of a reversal appear.
Key elements of the runaway gap strategy include identifying a gap that occurs during an existing trend, confirming with strong volume, setting a stop loss near the gap, and targeting continuation of the trend with no immediate reversal, aiming for further price movement in the same direction.
Exhaustion Gaps Strategy
Exhaustion gaps often mark the end of a trend and provide opportunities to profit from the reversal. For good profit you need to trade against the direction of the gap, anticipating that the price will reverse soon after the gap. You should wait for confirmation of the reversal (e.g., a bearish candle after a gap-up) before entering the trade.
Key elements of the exhaustion gap strategy include identifying a gap that occurs near the end of a strong trend, confirming with a volume decrease after the gap, setting a stop loss beyond the gap, and targeting a potential trend reversal as the price may soon move in the opposite direction.
Measuring Gaps
Measuring gaps can help you estimate how far a trend might go and allow you to stay in the trade longer for bigger profits. Once a measuring gap occurs, enter a trade in the direction of the trend and following the rules of the strategy. Use the size of the gap or the previous price movement to estimate the next price target. This strategy requires patience, as you may hold the trade longer to maximize profits.
Choosing the Right Gap for Your Trading Style
If you're looking for high-profit opportunities, focus on breakaway gaps and runaway gaps, as these indicate strong trends and offer the chance for significant gains. These gaps are ideal for trend-following and momentum traders who want to ride big price moves. On the other hand, exhaustion gaps can be highly profitable for traders who specialize in reversal trading, though they come with more risk. For short-term traders who prefer low-risk, quick trades a good choice are common gaps, but they offer less profit potential compared to the other types of gaps and are less important for those seeking bigger moves.
Conclusion
In conclusion, common gaps provide short-term opportunities for gap fill trades, while breakaway and runaway gaps offer profitable chances to ride strong trends by trading in the direction of the gap. Exhaustion gaps are ideal for spotting reversals, while measuring gaps help predict the trend’s continuation for larger profits. By identifying the type of gap and applying the right strategy, traders can capitalize on these opportunities while managing risk effectively.
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Reference List
For more information about Trading Gaps visit Unlock the Mystery of Gaps in Trading
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