If you are an active trader, learning how to trade the gaps in the stock market can be a profitable endeavor. A gap occurs when a stock closes at one price and opens at a price that is either higher or lower than the previous close. These gaps in the stock market can happen after the end of the trading day or even minute-to-minute. In order to try and make a profit, you must first be aware of the risks associated with gap trading.
- Before you trade you should always try to find out what caused the gap. For example, a company may make an earnings announcement after the closing bell signals the end of trading for the day. If the earnings are much different than what the market was expecting, a price gap may occur when trading begins the following day. Gaps in the stock market can also happen at any time during the trading day. If a sudden event in the world causes some big investors to panic, a gap will often occur. Try to find out the reason for the sudden price change before trading a gap intra-day.
- Once you decide to trade the gaps in the stock market, you will have to determine your course of action. Many traders will buy the stock as soon as trading begins for the day, depending on the reason they determine that the gap occurred. Other traders will wait for the gap to fill before entering a trade. Filling the gap is nothing more than having the stock’s price return to where it was when the gap occurred. For example, if a stock was trading at 25 and then gapped to 30, to fill the gap it would have to return to 25. If it does, the gap is considered filled.
- There are traders who will try to profit by trading the stock as it returns to the price of the gap. For example, if a stock was trading at 25 and gapped lower to 20, the trader would buy the stock at the lower price to try and profit if the price returns to fill the gap at 25.
- Gaps do not always get filled. This is the biggest problem when trying to trade the gaps in the stock market. Sometimes a gap is the beginning of an extended price move that lasts for years. The gap was never filled because the price kept moving in the same direction. This can be either up or down, it does not matter.
- Sometimes an economic or other unforeseen event causes a sweeping move across the entire stock market. This can result in multiple stocks with gaps on their charts. You can check several of the stocks you closely follow to see if a price gap occurred on one of the stock’s charts. If you find one with a gap, decide the best way to profit from it before you enter the trade.
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