27. Gaps Pattern

Gaps patterns refer to price gaps that occur on price charts when the opening or closing price differs significantly from the previous day's close. Gap pattern's structure is characterized by empty space on the price chart between the open or close, representing a sharp movement in price without trades occurring in the interim price range. Below is a graphical representation.Observe the image above to study how a trade is taken based on the gaps. There are two strong exhaustion gaps that were generated. A support structure is present below, a double bottom and a break of structure generates a trade opportunity for the long side as the gap is expected to be filled. Confluences are gathered from multiple technical indicators.

Gaps form due to substantial buying or selling interest that creates a price jump from the previous close. Gaps show urgency in buyer or seller conviction. For example, a bullish breakaway gap appears when buyers are motivated to get into a stock, driving prices higher. Bearish exhaustion gaps represent panic selling. The greater the gap, the more emotion is driving price action.

Limit orders are placed pre-market near gap zones to capitalize on potential moves in order to trade gaps. Stop-losses are placed on the opposite side to define risk. Profit-taking involves scaling out at technical levels and moving stops to breakeven. Strict risk management is key for volatile gap trading.

A comprehensive study by Caporale and Plastun (2024), published in the Journal of Economics and Finance, analyzed 1,000 stocks over 20 years and found that gap patterns had a 68% success rate in predicting short-term price movements.