The Implications of Price Gaps

Price gaps are simply areas on the bar chart where no trading has taken place. In a uptrend, prices open above the highest price of the previous day, leaving a gap or open space on the chart that is not filled during the day. In a downtrend, the day’s highest price is below the previous day’s low. Upside gaps are signs of market strength, while downside gaps are usually signs of weakness.

Gaps have different forecasting implications depending on which types they are and where they occur. There are three general types of gaps — the breakaway, runaway  and exhaustion gaps.

The Breakaway Gap. The breakaway gap usually occurs at the completion of an important price pattern, and usually signals the beginning of a significant market move. After a market has completed a major basing pattern, the breaking of resistance often occurs on a breakaway gap. The breaking of a major trendline, signaling a reversal of trend, might also see a breakaway gap.

Breakaway gaps usually occur on heavy volume. More often than not, breakaway gaps are not filled. As a rule, the heavier the volume after such a gap appears, the less likely it is to be filled. It’s important that prices not fall below gaps during an uptrend.

The Runaway or Measuring Gap. after the move has been underway for a while, somewhere around the middle of the move, prices will leap forward to form a second type of gap called the runaway gap. It is also called a measuring gap because it usually occurs at about the halfway point in a trned.

This type of gap reveals a situation where the market is moving effortlessly on moderate volume. In an uptrend, it’s a sign of market strength; in a downtrend, a sign of weakness. Runaway gaps act as support under the market on subsequent corrections and are often not filled. A close below the runaway gap is a negative sign in an uptrend.

The Exhaustion Gap. The exhaustion gap appears near the end of a market move. near the end of an uptrend, prices leap forward in a last gasp. however, that upward leap quickly fades and prices turn lower within a couple of days or within a week. When prices close under that last gap, it is usually a dead giveaway that the exhaustion gap has made its appearance. This is a classic example where falling below a gap in a uptrend has very bearish implications.