Gaps - An Important Trading Tool

A "gap" describes the stock price opening either at a higher or lower price than it reached at any time the previous day. These gaps in prices can be up or down and they can happen with any stock. If, during the trading day the stock continues to trade above the opening price, a gap will exist in the price chart.

Gaps are predominantly news driven, either earnings reports, analysts' upgrades or downgrades, market rumours or key people in the company giving a comment or perhaps buying or selling the company stock.  Regardless of the exact reason, gaps exist due to an event happening while the market is closed. The buying or selling pressure at the open of the next day will make the stock open at a different price than where it closed.

Gaps - Signs of a Possible Change

Gaps are important as they can offer evidence that something important has happened to the stock fundamentals or the psychology of the market buyers / sellers that accompanies this market movement. Gaps often indicate the beginning of a major move as they demonstrate strong buying or selling of a stock, If they occur at price levels that would otherwise be very significant, such as primarily areas of support and resistance they cannot be ignored.

The daily chart of BHP shows clear gaps in March and April of 2005 at key resistance levels. The first gap indicated broke the strong upward trend line, suggesting a major change in market sentiment was in play. BHP's share price then consolidated for a brief period of two weeks before gapping again, breaking the first resistance line shown. The very next day the share price gapped again, breaking a second resistance line.

Gaps clearly alert the market to a turn-around in market sentiment when they break key points of resistance and are a very useful tool for all traders and investors.