How To Trade The Gaps

Markets are always full of surprises and they are quite vividly displayed on charts in the form of Gaps. As a trader, we sometimes get caught on the wrong foot when the market gaps against your position. In such scenario we need to arrive at counter measures to absorb this volatility and execute some trades.

Traders more often than not get disoriented with the gap formation. Since gap is not something under our control we should look to find a way around it and enable ourselves to participate in the market action.

However if one pays some attention one can actually use the gaps to ones advantage. Trading gaps are one of the most popular trading methods as they are an indication of a momentum initiating on either side of the market.

For our understanding we have enumerated some scenarios that one encounters periodically on the charts. We have laid out how we can classify them and tae suitable action

Scenario 1: If a stock does gap above the prior day’s high, it is an Outside gap and will likely only fill until it reaches the prior high, which will act as support. If the markets are bullish, then expect a bounce here for a long.

Scenario 2: If the prices gap between the previous days high and low then such gaps are referred to as an Inside gap. One can expect the gap to be filled during the day. Such days are ideal for conducting range trades as the prior high will act as resistance and cause the stock to drop from that point, thus identifying a shorting opportunity.

Scenario 3: Trend identification is critical while trading. There are instances where the price gaps into previous Supply Zone. The obvious situation in such scenario would be some selling pressure emerging to push the price lower. As an alert trader one should see if the reaction disturbs the overall trend and if there is follow-through to the reaction. Else it would be a good spot to go contrarian.