Gaps in stocks occur frequently. For example, a stock may be trading between the price range of $29-$30 and suddenly gap up to $35 per share. Gaps represent a break in stock price continuity.

A gap in stock prices may represent a seismic shift in the underlying fundamentals or they might represent nothing. Most of the time, you will find common gaps in a stock price. A stock might be trading for $30 for several days and suddenly gap up to $35. In the next few days, the price action fills down the gap by trading back down to $30. Don’t trade gaps. They usually have light volume and represent nothing on the part of buyers or sellers.

Breakaway gaps are something different. Breakaway gaps occur with high volume and represent a seismic shift in the underlying fundamentals of the security. A stock price may trade in a certain price area for several weeks and then violently gaps up or down suddenly on day.

The strength of the breakaway gap is an indication that fundamental change has taken place in the way investors value the security. Now, you don’t need to immediately buy or sell at the gap because many things can happen after the gap. You need to confirm the gap.

There is another type of gap known as Continuation Gap that crops up in the middle of a trend. Now a continuation might be preceded by a breakaway gap or it might not. It depends. If the continuation gap is true, stock prices will not return to fill it. When a continuation gap occurs, look to trade in the direction of the continuation gap. Place the protective stop within the continuation gap region. An exhaustion gap occurs in a trend also but is different than a continuation gap. An exhaustion gap also occurs in the direction of the trend and it fills quickly meaning the price action returns to fill the prices in the gap. On the other hand in the case of a continuation gap, price action will never return the prices within the gap.

What causes the gaps to occur in stock prices? The most common cause the breaking news that usually takes place after the trading hours. So if the stock price had closed at $30 per share, you might find the stock price to open at $40 the next day when the stock market opens. So beware of sudden gaps that appear in stock prices!

Mr. Ahmad Hassam has done Masters from Harvard. Get the Ultimate Swing Trading Software FREE. Discover a forex robot that can double your money every month while you sleep. It made an astounding 2,270.30% in 2009!

This article was published on 21 Jan 2010 and has been viewed 593 times