Gap Trading: How to Trade Price Gaps in 6 Simple Steps

How to Trade Gaps

From time to time, you’ll be able to notice price gaps when trading the markets – these are blank areas in a trading chart where an asset’s price opens higher or lower from the previous day’s close. 


Generally, it is quite common that gaps tend to get filled at some point in time, which could be a great opportunity to make trading decisions and take advantage of these price gaps. So, let’s see how you can add this tool to your trading arsenal.

Key Points to Take Away

  • In trading, gaps are blank areas in a trading price chart that usually tend to get filled.
  • There are four types of trading gaps – common, breakaway, continuation, and exhaustion.
  • Gaps typically occur due to unexpected fundamental and technical events during times when the markets are closed.

What is a Gap in Trading?

First, in my view, the best way to explain a gap in trading is to see gapping happens on a candlestick chart.

Amazon Daily Chart Common Price Gap
Amazon Daily Chart Common Price Gap

As you can see in the chart above, a gap is simply an area in a chart where no trading activity has taken place, and there’s a sort of empty space from the previous closing price displayed in candlestick and bar charts. In financial terminology, this is known as gapping and is exactly what happened in the chart above when Amazon stock opened higher and in the following three trading days, the gap was filled. 

As we already know, due to the herd behavior in financial markets, a lot of people are looking at the same charts and are taking similar trading actions. Hence, many experienced traders exploit these gaps to make profitable trades.

Types of Gaps

There are 4 types of gaps’ price patterns you can find on trading charts. These are:

Common Gap

A common gap, also known as an area gap, is a price gap that occurs without any pattern or shape. These gaps normally happen due to technical reasons and in most cases tend to get filled quickly. (see image above)

Breakaway Gap

A breakaway gap is an untraded region that occurs at the end of a trend, or more accurately, at the end of a period when the market is in consolidation. Usually, it marks the end of the previous sideways region and the beginning of a new trend. Generally, breakaway gaps are less likely to get filled and if they do, it usually takes a long time for the gap to be filled.

Tesla Stock - Breakaway Gap
Tesla Stock – Breakaway Gap

Continuation (Runaway) Gap

As the name implies, continuation gaps usually occur in the middle of a price trend. So, when a continuation gap is identified, it means that the trend is very likely to continue. A runaway gap is also characterized by a significant gap and high volume.

Tesla Stock - Continuation Gap
Tesla Stock – Continuation Gap

Exhaustion Gap

An exhaustion gap typically occurs at the end of a long market trend when asset prices are testing new record highs or lows. As a result, this type of gap signals a taking profit condition and a reversal of the prior trend. As you can see in the chart below, once the exhaustion gap occurs, the price moves in the opposite direction.

Tesla Stock - Exhaustion Gap
Tesla Stock – Exhaustion Gap

Why Does a Price Gap Occur?

Apart from the cryptocurrency market, all other markets have opening and closing times. The forex market, for instance, is open 24/5 and is closed on Saturday and Sunday. Most stock markets around the world are open for 8-9 hours a day. This leaves plenty of time for unexpected events to influence assets’ prices in times when the markets are closed. Then, when the market reopens again, the fundamental factor that was released is being priced in and thus, the gaps occur when a financial instrument opens at a lower or a higher price.

As a matter of fact, central banks and private companies often prefer to release important data at times when the markets are closed (They usually do that to reduce volatility and market noise). Eventually, these unexpected events such as earnings reports, economic data, and political issues may create a gap in the market. 

Bear in mind that a gap can also occur when you are holding a position overnight. For that reason, it is also crucial to closely follow the economic calendar, companies earning results, and commodities reports. 

So, all things considered, gaps are usually created by fundamental underlying factors, especially in the stock market. In the foreign exchange market, it is not very common to find gaps as the market runs 24 hours five days a week. However, in some cases, you might be able to identify a gap in certain currency pairs on Sunday/Monday when the market opens.

How to Trade Gaps?

Before we delve into the details, you should know that trading the gaps does not actually involve the use of any complex trading strategies, and is usually not a trading strategy you could solely focus on. Most likely, you are not going to search price gaps in the market and make it your top strategy. Still, it’s a good trick and an interesting way to ‘hack’ the markets. 

In my opinion, it is best to keep this method of trading in the back of your mind when you start trading and occasionally enter trades when you identify a gap in a certain market.

So, how does it work? In a nutshell, traders who use gap trading strategies try to identify gaps between the opening price and the closing price on a trading chart and use these gaps as the main reason to buy or sell an asset. The decision obviously depends on the asset’s market sentiment and the type of gap price pattern that was formed. However, this is the main rationalism behind this type of trading – once a trader notices the market is about to close the gap, the trader predicts that the price will cover all the gap regions, which gives the trader an evaluation of the next price movement. 

Keeping the above in mind, here are some basic rules to take into account when trading gaps:

  1. Try to identify the type of gap and the market sentiment before the gap was created
  2. Follow the news and make sure you understand what caused the gap
  3. Always wait for the first candlestick to be completed
  4. If the market goes against you, get out. Once the price reaches near-gap levels, you can enter a trade again. 
  5. Once the asset starts to fill the gap, stay until the end. After the gap occurred and the asset’s price has started to fill the gap, prices rarely stop and typically cover the entire region of the gap. 
  6. Add a volume technical analysis indicator.

So, What’s the Big Deal About Gap Trading?

The bottom line – Much like using Doji candlestick chart patterns in order to make trading decisions, the use of price gaps in trading is something that should come naturally. There’s no need to learn how to use or analyze it – instead, you need to be aware of this occurrence and grab the opportunity whenever you see it. 

As a general rule, I wouldn’t say that gaps are always automatically filled. Occasionally, it takes days, weeks, and even months until the gap is filled. However, I don’t think I’ve seen many cases at which a price gap was not filled (unless the asset is illiquid and there’s low volume). So, taking this ‘trick’ and applying it to your trading routine could be extremely useful for you.  

FAQs

How to trade gaps successfully?

Frankly, trading gaps might be a tricky business. While spotting gaps does not require any special trading skills, it could be quite a challenge to identify the type of gap.  Still, if you master your skills in identifying the type of gap and when to enter a trade, gap trading offers lots of trading opportunities. 

One tip that might be helpful – knowing when to enter a trade once you notice a gap is not an easy task, especially if you are not familiar with the stock or the asset you are trading on. That said, in the vast majority of cases when the asset starts filling the gap, the price will go until the point it fills the entire region. This trading method is something you should take into your decision process and use as much as possible.

How to trade stock gaps?

As we mentioned in our guide, price gaps are more common in the stock market than in other markets, largely because the stock markets are open for several hours a day.  To trade stock gaps, you need to watch the pre-market and the first hour after the stock market opens. Then, once you identify a price gap, wait for the next candle to be completed and try to identify the type of gap. Whenever the stock’s price starts filling the gap, this is your trade – meaning, you need to stay until it covers the entire gap. 

Additionally, one of the key things that create gaps in the stock markets is earnings report so it is advisable to always be alert of reports released by public companies.

How to determine stock gaps to trade?

Generally, there are a few services online that provide a stock screener with alerts about stock gaps. This includes Finviz, Chartmill, and even TradingView. Another way to find stock gaps is to create your own stock screener, and independently find stock gaps during the pre-market session. 

Where to place stop loss when trading gaps?

Another gap trading strategy is to enter a position once the asset has started to fill the gap, and place the stop loss at the level at which the price hits yesterday’s close. This way, if you believe the asset is going to fill the gap and continue this trend, you can benefit from using the previous close as a protection level and try to ‘squeeze’ the trade. 

Stock Market Crash – Here’s What You Need to Know Before It Happens

Here’s a known fact – The stock market crashes from time to time. When and why would it happen? No one knows. In the aspect of the economy and financial markets, we can only predict the future by looking at the past. 

The right question to ask would be – how often does the stock market crash? Well, the data shows that every eight years on average (more or less), stock markets around the world are facing one major crash, not including minor corrections and downtrends in between.  

While long-term investors fear the unknown – for short-term traders, a stock market is, in fact, an opportunity. There’s high volatility and some assets are supposedly desirable during a market crash. But regardless of the type of trader you are, you need to keep in mind some crucial factors about a stock market crash – how to predict and identify a crash in the stock market, what assets to buy and trade, and what to do during and at the end of the crash.

How to Predict or Identify a Stock Market Crash?

Predicting a crash in the stock market is not an easy thing, and usually, there must be a trigger to change the market sentiment that causes fear in the markets. 

If you’ve watched the ‘Big Short’ movie, then you probably remember the character of Christiane Bale, Michael Burry who was one of the first people in the industry to predict the economic crisis in 2008. Burry was betting against mortgage securities before the financial crisis had begun and had to wait for several months until his prediction became true. Luckily for Burry, it worked. But for retail traders, trying to predict the exact timing of a crash in the markets could end up in losing money. Forget about Black Monday, Black Tuesday, and the horrible ‘late October‘ – usually, it doesn’t work this way. Predicting the exact day or week when stocks experience a sharp decline is almost an impossible thing to do.

But while predicting a stock market crash would be an extremely difficult thing to do, you might be able to identify the beginning of the crash. Typically, there are two warning signs that a crash in the stock markets is coming – panic selling, and a big drop in share prices. In some cases, stock exchanges may announce a trading halt, which is a temporary suspension of trading on an exchange for a particular day. These circuit breakers, also known as trading curbs or trading halts, are measures taken by regulators to stop panic-selling on stock exchanges, and typically indicate the beginning of a bear market.

Another useful tool to follow is the VIX index, which is the CBOE volatility index and measures the expectations for volatility in the US stock exchange over the upcoming 30 days. When VIX rises, it’s a strong indicator that the markets are about to get volatile and the uncertainty in the markets rises. Evidently, this is what happened in the 2008 crash and in the Covid-19 pandemic mini-crash in 2020 (as you can see in the chart below).

Another important asset class to follow and check in order to be able to identify a drop in stock prices is Bond yields/prices. Generally, the fixed income market and the stock market are in a sort of competition. Thus, lower bond yields lead to higher stock prices, and vice versa. 

Therefore, because bond yields are normally the first financial instruments to react to any macroeconomic developments, every trader must add bond yields to its watchlist and follow these assets on a daily basis. Additionally, when there’s uncertainty in the market (like the current situation), it is important to be alert to any meetings by the Federal Reserve Bank and other leading Central Banks around the globe.

What to Trade If the Stock Market Crashes?

The financial system is based on trust, more than anything else. When the stock markets crash, the global economic system is in an unsustainable situation, which raises lots of questions and doubts from ordinary people. Consequently, people are looking for ‘safe-haven assets, or in other words, the most needed and rare assets on our planet. 

So, with that in mind, here are some financial assets that are expected to face high volatility and rise in times of a stock market decline. 

  • The US Dollar – The USD is still the most dominant currency in the world and is known as the most stable currency in times of economic downturn.
  • Precious Metals – Precious metals are considered to be the most valuable assets in nature and therefore, the demand for these assets increases in case there’s a crisis in equity markets. Some of these assets include Gold, Silver, Copper, Aluminium, Platinum, etc. 
  • Grains – Even though grains’ prices are expected to slightly drop at times of crisis due to a decrease in demand, they are still some of the safest assets to buy and hold during a recession. These assets include Wheat, Corn, Soybean, Rice, Rapeseed, etc. 
  • Bitcoin – Yes, this strange cryptocurrency which many people still don’t understand the logic behind it somehow has become a safe haven asset. You may like it or not, but it seems that Bitcoin is now a protection asset against inflation, uncertainty, and stock market crash. 

But making profits in times of a stock market crash is not only by finding good assets to buy. Instead, you can also bet against the stock market and the economic growth in general (much like Muchael Burry). By choosing the right brokerage firm you can short sell assets, meaning you borrow the asset from your broker and send it back at a later date. This way, you can also make profits in the markets by betting that prices will decrease in value. 

If this is the case, you can short sell stock indices like S&P 500, DAX30, Nasdaq100, Dow  Jones Industrial Average 30, and Nikkei225. What’s more, you can short sell individual shares via a traditional brokerage firm or via CFDs. You should be aware that there are pros and cons to each way of short-selling assets, which we outlined in detail in this guide. (we’ll make another guide on this topic).

“Sooner or later a crash is coming, and it may be terrific.” In September 1929, Roger Babson warned investors that the stock market is about to collapse. On the same day, the stock market dropped 3% and the famous Wall Street crash and Great Depression started. This is known as the “Babson Break”.

How to Trade a Stock Market Crash?

Frankly, there’s no decisive answer to this question. There are plenty of asset options out there to trade during a stock market crash. You can buy put options on indices, short indices via CFDs, buy the US dollar, and invest in valuable commodities. The trick is not what to buy but when, and how to do that?

In essence, a market crash is a short-term phenomenon that happens quickly. And during a market crash, almost any asset out there in the markets moves in a certain direction. This means that there’s high volatility and high risk, but also lots of opportunities. Personally, I’ve heard many stories of traders that made nice profits at times of falling markets, including…. Osama Bin Laden who allegedly shorted the market before the 9/11 attack.

But that’s not a good example, right? For the average trader, the best thing to do is to focus on 1-3 assets, understand the implication of a stock market on the particular asset, and trade every day as a routine. The good thing in times of high volatility is that you can bounce back from a losing trading day in the next trading day, finding new trading opportunities and catching another trend. 

Bear in mind, however, that there are no specific rules of how to trade correctly during a stock market crash. Having said that, in my opinion, it’s better to focus on a trend trading strategy rather than a range trading strategy. Further, it’s also a good idea to occasionally ‘leave the charts’ and search for relevant market news and fundamental analysis. In times of uncertainty, these are the main factors that impact the markets – economic events, statements from politicians, financial leaders, central bankers, and of course, Elon Musk.

What to Do When A Stock Market Crash Ends?

Ironically, stock market indices are designed to rise in value over the long term. After all, the S&P 500, for example, represents the largest 500 US corporations at any given time. So, if a company is no longer successful, it will be removed from the index and replaced by another profitable company. 

A lot of investors, therefore, see a market crash as great timing to buy stocks and indices. Last year, for example, stock markets saw a record crash in March when the Coronavirus pandemic emerged followed by a record rebound in the following months. The surprising recovery has expanded the disparity between markets and the real economy, which by many opinions, is the main catalyst for the ‘upcoming’ market collapse. 

Since the fear of a stock market crash grows lately, it would be a smart idea to know what to do during a market crash, but far more importantly, what to do when the stock market crash ends. If you are a long-term investor, then the end of a stock market crash is clearly the best time to buy stocks, as well as stock indices. 

If you already have a portfolio of stocks, retirement funds, etc – then you need to decide whether you stay in markets during the crash or take all your money out and reinvest your funds when the stock market crash ends. From my experience, this depends on two factors – the type of investor you are and the complexity of your portfolio. If you are not an active investor and you have a diversified and well-managed portfolio, the best thing to do is to… do nothing. After all, the stock markets rebound quite quickly over the last two decades with the help of central banks and the policy of quantitative easing. 

On the other hand, if you have the ability to close all your positions, then it would be best to close all your positions, sit on the fence, and get into the markets again at a later date. There’s no reason to see your portfolio reduced by 40%-50% in a short period of time. 

What’s Next?

Right now, there are mixed opinions about whether the markets are close to another major crash or there’s more room for stocks to rise, or at least stay in the same levels for the next year or two. In my view, where there’s smoke, there might be fire – so, every trader or investor should be ready for a significant drop in stock prices in the near future. After the unprecedented recovery in stock markets over the last year and a half, the markets are expected to at least correct, if not more than that. A quick look at the S&P 500 all-time chart shows us a remarkable uptrend without any major correction in between since the Covid-19 recovery has started. 

Looking ahead, there are lots of speculations that the stock market is heading for a crash. According to a survey by Allianz Life, 54% of Americans believe that stock prices can no longer rise, largely due to concerns over the Covid-19 pandemic, the rising inflation in the US and globally, and the expectation for an increase in interest rates. One analyst that joins this prediction is Robert Kiyosaki, the author of Rich Dad Poor Dad, who recently said we are heading for the ‘biggest crash in world history’

Still, over the last decade and especially over the last year, there’s a gap between predictions and reality. The markets can consolidate before making the next big move, and the next crash could eventually happen in 2022 or… 

One thing is certain – a stock market crash is expected to come at some point in time. And, unlike long-term investors, for traders, a stock market crash is an opportunity and is an exciting period to trade. Do it, get in, and trade. Even if you lose money when trading during a crisis, it’s a lesson you must learn very well. Perhaps you’ll be ready for the next time the stock market will crash…

Share Trading or CFD Broker – Which One is Better to Buy and Short Sell Shares?

Before you start buying and short selling shares, you need to make a decision of what platform you are going to use and what is the preferred form of buying and short selling shares. For that purpose, a user has two options – via share trading platform (also known as traditional brokerage firm), or via Contract for Difference (CFDs). 

There are some major differences between the two forms of trading shares as each one comes with its own pros and cons. It all depends on the resources you have to trade and what you are ultimately trying to achieve. So, in this article, we’ll help you understand the key difference between trading CFDs and share trading, and help you figure out which one is better for you. 

What is the Difference Between Trading Shares Outright and Trading CFDs?

The most notable difference between trading stocks outright and contracts for difference is that when you buy and sell a CFD contract you are essentially speculating on the price of the asset without owning it. In other words, the CFD market is sort of a derivative market where traders gain exposure to stock global markets and can speculate on the price movements of underlying assets versus the broker or other market participants but without owning and exchanging the underlying asset. 

For example, if you are buying shares of Apple via a traditional brokerage, you basically own security or a paper that shows you have ownership in the company. Therefore, you own a portion of the Apple Corporation, and you are entitled to dividends and other benefits that shareholders receive. For that matter, you need a brokerage firm that connects you to the exchange where you can directly buy Apple stock. 

When you trade CFDs, on the other hand, you have no ownership and you do not receive any security or paper when you make a purchase. Instead, CFDs work in a way that you simply enter into an agreement with your brokerage firm or another investor who will pay (or receive) the difference between the price you enter the position and the share price at which you closed it. Because CFDs are a derivative form of trading done outside a stock exchange, brokers have the ability to offer retail traders key features that make this type of trading product very attractive (and risky). These include low fees, high leverage ratio, advanced trading platforms at no cost, the ability to short sell stocks with no margin requirements, and more. 

What are CFDs?

CFDs are complex instruments that allow traders to enter an agreement with a brokerage firm about the future price of an underlying asset. 

CFD Trading vs Share Trading – Pros and Cons

Apart from the above, there are other crucial differences between trading shares via a traditional brokerage firm and trading shares via CFDs. Below, you can find some of the pros and cons of each way in which you can trade shares.   

Pros Cons
Trading Shares OutrightYou get ownership in a company and you are entitled to shareholder privilegesActive traders may receive rebates; You get access to the real market including level 2 order book; You get market access to a wider range of stocksHigh feesHigh margin requirement if you want to short sell shares; You need to pay annual management fees; Because there are strict requirements to open a margin account, you can only buy shares and make profits from rising prices 
Contract for Difference (CFDs)Low fees, only spread – make CFD trading cheaperHigh leverage ratio(typically around 5:1 or 10:1 for shares)Low minimum deposit requirement; Some brokers pay dividends when you hold share CFDsMost brokers provide access to financial markets including foreign exchange markets, commodity global markets, ETFs, cryptos, indices, etc.Overnight fees – CFDs are less suitable for long term positionsCFDs can be quite risky due to the high leverage ratio; No voting rights; Trading CFDs with spreads makes it difficult to get in and out of positions

Example of Stock CFD Trade vs Stock Outright Trade

For many people, the difference between trading stock CFDs and stock trading outright is somewhat vague and unclear. So, if things are not yet clear for you, an example is the best way to clarify the difference between the two forms of buying shares.

CFD TradeShare Dealing Trade
Pfizer stock price$42.0 – $42.05$42.0 – $42.01
FeeTrading spread + overnight freeTrading spread, fixed fee, and annual management fees
Overnight feeYesNo
Number of Shares100100
Position size$4205$4201
Funds Required to Open the Position$420.5 (with a leverage ratio of 10:1)$4201
Close Position at$45$45
Profit/Return in %$295/70%$295/%7

Should You Buy and Short Sell Stocks via CFDs or Outright?

So, taking the above into consideration, you eventually need to decide what’s the best way for you to trade stocks – CFDs or directly from the exchange? My honest opinion – if you are planning to make a long term portfolio of stocks (including dividend stocks) with a large investment, it would be better for you to open an account at a traditional brokerage firm and pay one time commission when you buy and sell assets and annual management fees. 

The reason for that is that when buying stock CFDs, you need to pay an overnight fee. It’s not a high fee but it might impact your decision to hold stocks for long periods of time, particularly when you are in a losing trade. 

Another reason to trade via share trading broker is in case you want to get access to a level 2 order book, which helps you get the ‘feeling of a market’. With a level 2 order book, you get to see the buyers and sellers, quantities of each trade, stock market action, etc. This is a feature that is not available with CFDs.

Further, share trading brokers usually provide access to all stocks listed on a certain stock exchange. For example, if you open an account with a traditional brokerage firm, you’ll be able to trade thousands of shares from various exchanges including penny stocks. In comparison, CFD providers typically provide a limited selection of popular and highly traded stocks.

On the other hand, if you are planning to actively trade stocks and get in and out of positions several times a day or a week, then CFDs might be the better option. The logic behind that is obviously the high cost of buying shares outright. When you trade shares on a traditional brokerage firm, meaning you buy shares directly from the exchange, you need to take into account an average fee per trade of around $5-$8. In simple terms, you need to pay a fee of $5-$8 when you enter the position and when you close the position. 

So, assuming you buy 100 shares of AT&T at a price of $26 and the fee per trade at your brokerage firm stands at $7 per trade, you’ll be profitable only when the share price rises above $26.14. Not something crazy, it could definitely happen – but for a day trader, that is a lot. 

With CFDs, you simply don’t pay any fixed trading commissions. Instead, you pay a spread between the bid and ask price and the overnight fee

What’s more? obviously the budget you want to invest in. Usually, share trading brokerage firms require a high amount of initial capital to open an investment account. For a margin trading account, most traditional brokers maintain a minimum deposit of $2000-$5000. CFD brokers, on the other hand, enable users to start trading with low deposits, and the account creation process is easier than with traditional brokers.

For example, Switch Markets enables users to open a CFD trading account with as little as $50.

 Additionally, short-selling shares via a traditional broker are quite a complicated process when compared to a CFD provider.  This is why most people use traditional brokerage platforms to buy assets for the long term while trading stock CFDs is known as a better way in order to apply short-term trading strategies. There are no limitations to short sell shares, so a trader can easily make profits in rising and falling markets.

At last, leverage! This is, for some people, the primary reason to trade shares with CFDs. A leverage ratio of 5:1 or 10:1 for stock trading is a lot, as shown in the example above. With an investment of $1000, you can essentially trade the markets with $5000 or $10,000 (depending on the leverage ratio provided by the broker). 

With that in mind, you need to remember that a leveraged CFD trade is a double edge sword – it certainly increases the potential for profits but also increases the risks involved in trading and the risk of losing money rapidly. 

TIP

If you are a short-term trader looking to open an investment account with a low initial investment and get access to high leveraged trading as well as margin trading, you should trade stocks CFDs. Otherwise, as we mentioned above, the ideal way for long-term investors is to buy stocks via share trading broker or private investment banks.

The Bottom Line – CFDs vs Stocks?

To conclude, there are major advantages to each form of share trading. The key difference between CFDs vs stocks is the ownership of the underlying asset. This basically means that trading CFDs comes with margin and low trading costs and, therefore, is more suited for short-term traders. Meanwhile, share trading via traditional brokers is known as an ideal form of stock investing for long-term investors.

Finally, in order for you to make the right decision, below we have matched the best form of share trading for each type of trader or trading strategy.  

Type of Trader/Trading StrategyCFDs/Share Trading
Long Term InvestorShare Trading
Swing/Medium Term InvestorsCFDs
Day TraderBoth – Depending on the budget and the trading strategy
Low/Medium Budget TraderCFDs
Professional Traders/Level 2 order bookShare Trading
Trading Strategy – Short sell PositionsCFDs

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