Trading Price Gaps: The Factors to Note
Gaps provide ample opportunities for the flexible spread trader
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If you’ve ever spread bet on currencies or commodities, then you
probably have a pretty good real life experience of what this article is about! While price jumps occur across all markets, they tend to be more frequent in the more volatile markets – and they don’t come much more volatile than currencies and commodity markets. In this article, I will look at the various types of gaps and more importantly, how you can enhance your spread betting by trading them correctly.
Learn to Identify the different types of stock price Gaps
There are four main types of stock price gaps: breakaway-gap,
continuation-gap, common-gap and exhaustion-gap. Each of these happens at different stages of a stock price move. Just as important is the fact that the appropriate spread betting strategy to use depends on the type of gap in question, so for practical spread betting purposes, being able to identify the type of gap that is being formed is crucial.
The first type of gap is the breakaway gap. As the name implies, a breakaway gap occurs when a stock price ‘breaks away’ from a previous area of consolidation or base formation. This areas tend to be either support levels if the break away gap is to the upside or resistance levels if the break away gap is to the downside. Moreover, once formed, the price level at which the breakaway gap formed often becomes support of resistance too (depending on the direction of the break).
Usually, the breakaway gap occurs on significantly high volume, which serves as a confirmation of change in investor sentiment toward the stock or market. Spread betting in the direction of the break away gap has a high probSpreadbet Traderlity of delivery excellent profits.
Quite often, when a stock is in a strong trend, it will gap strongly (up or down) in the direction of the prevailing trend. These types of gaps are known as continuation gaps. Continuation gaps always occur during powerful trends. So, in an up trend, the stock gaps up while in a down trend, the stock gaps down on its way to lower prices. Continuation gaps are usually accompanied by strong spike in trading volume.
To the pro trader or financial spread better, continuation gaps provide confirmation that the trend remains in force and that the market sentiment behind the ongoing trend remains very strong. In these situations, it pays to spread bet in line with the trend.
Now, not all gaps represent important or lasting market sentiment. Indeed, the most frequently occurring type of gaps, known as the ‘common gap’, are typically short lived jumps in prices on way or the other. One thing that is statistically clear about common gaps is that they are short lived and prices revert to close or ‘fill’ the gaps pretty quickly.
For skilled financial spread betters or traders, this price ‘anomaly’ presents a nice little earner! Since common gaps get filled in a matter of days (or even hours in some cases) in almost all cases, a highly profitable spread betting strategy is to adopt a contrarian view and bet against the price gap. So if the price gaps up, a spread better sells short and if conversely, the price gaps down, a pro would place a buy
spread bet. Those who spread bet the FTSE 100 intra day would be aware of how often this sort of opportunities present themselves in the Footsie. Literally free money for those willing to take the risk!
To make this simple strategy even more effective, professional traders drill down further before placing a bet. Basically, you want to be a contrarian against a common gap in a stock price only if that common gap occurs against the dominant trend. So, if the stock price is in a downtrend and there is a common gap to the upside, then that presents a nice spread betting opportunity for short selling.
In a way, exhaustion gaps are like the opposite of breakaway gaps. This is because while breakaway gaps occur at the start of a new trend, exhaustion gaps occur at the end of trends.
Many novice spread betters ask how to differentiate between an exhaustion gap and a continuation gap.
The primary difference between exhaustion gaps and continuation gaps is that with continuation gaps, the stock goes on to make a higher high. That is, there is clear technical evidence of trend continuation. On the other hand, exhaustion gaps are not followed up by the basic trend confirmation signal of higher highs that you would follow continuation gaps. In contrast, exhaustion gaps tend to be confirmed with a reversal in
prices. Besides these methods of differentiation, there is no other hard and fast rule for telling in advance whether a gap is an exhaustion gap or a continuation gap. But if you adopt the spread betting approach that we advocate on this site, you would go into every trade only after having stacked the odds in your favour with various trade confirmation signals and then apply trading discipline and efficient money management principles. These allow you to spread bet with the confidence of a
In conclusion, gaps typically reflect sentiment among traders. For those willing to study and apply rigorous risk control and money management, gaps present opportunities for spread betting profits.
If you enjoyed this article on how to trade gaps, then click here for more insightful articles to hone your spread betting skills