Understanding Gaps in Investment Trading Analysis
In investment trading technical analysis, a gap is one of the more important of the special bar configurations. A gap is a major, visible discontinuity between two price bars on a chart. Because every bar encompasses all the investments transactions made during a specific period, a gap marks the absence of any transactions at the prices covered by the gap.
Gaps are often the result of positive or negative news, like earnings or some other event, whether true or invented (rumors). Events are the source of most key price moves, including trends, whether starting or stopping. Prices don’t, on the whole, move randomly — traders have reasons, right or wrong, to buy and sell. Even the strongest trend can be broken by a piece of fresh news contrary to the trend direction. Authentically big news trumps the chart (nearly) every time.
The gap is a void — no demand if there was supply and no supply if there was demand, at least not at those prices. Prices had to shift considerably in order for supply and demand to meet again and for both buyers and sellers to be satisfied. On daily charts, a gap is initially seen when the opening price today diverges dramatically from yesterday’s high or low, although you can also see gaps between bars on intraday charts.
You can identify a gap at the open, but you can’t measure a gap until the day’s trading is over. Then you measure it from yesterday’s high to today’s low (for an upside gap) or from yesterday’s low to today’s high (for a downside gap).
The gap is between the bars, not between the opens and closes. If the security opens on a gap but then the gap is filled during the day, the gap doesn’t show up on a daily chart. The same thing is true if a security gaps during the day on an hourly chart — the daily bar doesn’t show it.