The Art of Gaps in Trading

Generating Simple Trading Signals From Gaps

Market gaps, often perceived as abrupt price changes between trading sessions, are common phenomena in financial markets. They represent areas on a chart where no trading activity has taken place, typically resulting from significant news events, earnings reports, or changes in market sentiment.

This article sheds more light on this phenomena and presents a simple trading strategy based on them.

What are Market Gaps?

Gaps occur when the price of a security opens significantly higher or lower than its previous close, resulting in a gap on the price chart. These gaps can be due to various reasons, including after-hours news, earnings reports, or significant market events.

Understanding and identifying these gaps can offer traders unique opportunities to profit. Gaps can occur in various market conditions, each signaling different implications for traders. They are generally classified into four types: common, breakaway, runaway (or continuation), and exhaustion gaps. Our main focus is on common gaps, which are traded through a mean-reversion mecanism (i.e. contrarian). Each type provides distinct insights into market behavior and potential future price movements.