Trading Strategy Using Gap
Some traders use gaps as insight for trading. For example if a gap occurs relatively early in a trend, then it may be a breakaway or runaway gap, which allows the trader to know where the price will move next.
Some other traders use gaps for trading. Traders can enter positions after the gap occurs. These strategies are called playing the gap.
Buy When Gap (Up)
Day traders often refer to this strategy as the gap and go. A position that can be taken on the day the gap occurs, with the stop loss usually placed below the gap bar. The gap must occur above a significant resistance level and with a large volume to increase the chances of profit. Alternatively, the trader can wait for the price to fill the gap and place a limit order to buy near the previous day's close.
Selling When Gap (Down)
The strategy is similar to buying in the gap (up), in this the trader is short selling following the gap down.
Fighting the Gap
Being contradictory may be a strategy when there is a gap. Traders can take the opposite action of the gap. Because there is an assumption among traders that most of the gaps will be filled (closed) over time, either in the long or short term. For example, when there is a gap down, a trader can buy and place a stop loss at the bottom of the gap bar, and set a profit target near the area the gap will close.
Gap as an Investment Signal
Breakaway gap and runaway gap can both indicate that there is a trend that can be exploited. Therefore, traders can follow the gap by starting positions in the direction of the gap (usually looking for a higher gap). Traders may be able to hold trading positions until an exhaustion gap occurs, or until a trailing stop hits to figure out when to exit.
Time Gap Will Happen
No one can see the future of a stock's price, but gaps are possible after the announcement of positive or negative news, especially if the news was unexpected or better than expected. The shock of positive earnings news or a drop in earnings, news that a stock is an acquisition target, or the release of a new product, can all result in a Gap.
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