Gaps occur when there is no trading of financial instruments
in between a two different price levels. They can be easily noticed from
trading charts, where one worm stops a place and starts from a different place.
Gaps occur for all type of financial instruments like stocks, options, forex
and futures, and are more predominant is volatile markets with less liquidity.
Usually gaps are created when traders collectively respond to news or rumors.
Gaps can be of 4 types:
1) Breakaway gap, 2) Exhaustion gap, 3) Common gap and 4) Continuation gap.
Breakaway gaps are created when the stocks are at the start of bullish or bearish trends. Exhaustion gaps are created when the stocks are at the end of bullish/bearish trends. Common or area or trading gaps are created as a result of normal trading practices and they do not give any specific messages. Continuation or runaway or measuring gap is created at the middle of a trend in same direction of trend and is used by traders as a measure calculating the longevity of the trend.
The price differences occurred as a result of a Gap is often corrected in subsequent trading hours. This process is called ‘gap filling’ or fading (if the gap is filled in same trading day). Common and exhaustion gaps are filled more often than breakaway and continuation gaps. Many day traders and swing traders take advantages of specific gap trading systems and technical analysis tools to profit from gaps.