Dominate the Markets with Smart Technical Analysis TA 101 – Part 15
Markets with Smart Technical Analysis Gaps
Price charts often have blank spaces known as gaps. They represent times when no shares were traded within a particular price range. Gaps result from extraordinary buying or selling interest developing when the market is closed. When the market opens, the price is raised or lowered enough to satisfy all of the buying or selling orders.
For an up gap to form, the low price after market close on the day of the up gap must be higher than the high price of the previous day. Up gaps are generally regarded as positive. The high price of a down gap day after market close must be lower than the low price of the previous day; this is the exact opposite of an up gap. Down gaps are usually considered bearish.
Up and down gaps can form on daily, weekly or monthly charts and are considered significant when accompanied with higher than average volume.
For very lightly traded securities, a price chart with gaps almost every day should be avoided. Prices often gap up or down at market open and then close the gap before market close. Such temporary intraday gaps should not be considered as having anything more significance than normal market volatility.
Many investors mistakenly believe that gaps influence future prices to the point of eventually filling the gap. Instances where gaps close within a few days of forming can be significant. However, gap formation has little to no effect on price action for several weeks or months.
When accompanied by above-average volume, breakaway gaps indicate a shift in market perception regarding a security’s future prospects. When a security rises after a prolonged decline, extended base, or consolidation period, a bullish breakaway gap occurs. A bearish breakaway gap forms when a security gaps down after an extended advance, an extended top or a consolidation period.
In response to a sharp move or within a trading range, common gaps occur. These discrepancies are not the result of a shift in market psychology; rather, they are the result of price volatility or a brief imbalance between supply and demand. For instance, if a security has lost 20% in a week and has gaps up, this would be regarded as a typical gap and unlikely to indicate a trend shift. Or, if a gap appears in the middle of a trading range between $20 and $30, it is most likely a common gap. Near the middle of a short or intermediate trend in the same direction, continuation gaps form. These gaps indicate that the previous trend will continue. Continuation gaps are also known as measuring or runaway gaps. These gaps can be triggered by news events that bring more market attention to a security.
In the direction of long-term trends, exhaustion gaps occur. For an exhaustion gap to be considered valid, prices should reverse soon after the gap and close the gap. The extent of a trend is widely reported in the later stages of the trend, eventually resulting in a trading surge that cannot be sustained. These occurrences frequently signal the trend’s end. In part 16 we’ll take a look at Candlestick Chart Patterns
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