Upside and downside price gaps
sometimes provide solid clues both for 'confirming' trend reversals
and providing a gauge for the duration of a next move in the market.
Anyone who's been in London or lived there for a time and rode the 'tubes' (subway) remembers this urgent and frequent announcement to "mind the gap!". This announcement was about the space between the car and the platform. In trading, chart clues about the trend both in direction and duration, can be found by 'minding' the so-called CHART GAPS.
So-called chart or price 'gaps' on DAILY charts of a commodity, stocks, stock indexes or other financial instruments like bonds and currencies result in overnight news or order flows that cause a next days Opening to be substantially above or below the prior day's Close.
Downside price gap: The (daily) High is below the prior day's Low.
Upside price gap: The (daily) Low is above the prior day's High.
In stocks, because of the way that price reporting is done between the New York Stock Exchange universe (affecting the S&P Indices especially) and the Nasdaq, you mostly see either upside or downside price gaps just on the Nasdaq indexes. Not so, on NYSE-listed individual equities: as with Nasdaq-listed stocks, you see where there are upside daily chart gaps (imbalance on buy side) or downside price gaps (order imbalance on sell side).
COMMON PATTERNS WITH CHART GAPS:
Any price gap is the distance between a daily High and a subsequent daily Low; or, the distance between a daily Low and a subsequent daily High. A GAP AREA IS A PRICE RANGE WHERE NO TRADE OCCURRED THAT DAY.
An Upside (daily) chart/price gap after a prolonged decline, may also be a 'signal' of an upside TREND reversal. Such gaps are sometimes called upside breakaway gaps as the trend breaks in the opposite direction.
A downside (daily) chart gap(s) after a prolonged advance, may also be a 'signal' of an upside TREND reversal. Such a pattern is also termed in trader/analyst speak as a downside gap reversal or downside 'breakaway' gap.
I can illustrate chart gaps by highlighting recent daily chart gaps in the Nasdaq 100 (NDX), which adds to a type of GAP recognition and knowledge that helps to see when to switch from intermediate bullish to bearish strategies and vice versa.
Another common pattern with chart gaps is that the area where NO trading took place that day (and perhaps in subsequent days), will EVENTUALLY get 'filled in' by a future day(s) with trading that takes prices from one end of a prior price gap to the other end.
WHEN A PRICE GAP GETS 'FILLED IN' BY LATER TRADE IN A PRICE ZONE WHERE THERE WAS PREVIOUSLY NO BUYING AND SELLING MATCHED AT THOSE LEVELS, THE FILLED IN GAP SOMETIMES IF NOT OFTEN THEN POINTS TO WHERE THERE IS TECHNICAL SUPPORT OR RESISTANCE.
A pullback to the low end of a prior UPSIDE GAP will often bring in buying and becomes an area of technical support.
A run up to the top end of a prior DOWNSIDE GAP will often bring in selling and becomes an area of technical resistance.
So-called measuring gaps are price gaps that have often tended to occur about HALF WAY in a move. In the NDX daily chart again reproduced below, for each major move in the Nas 100, there was an upside or downside breakaway gap, followed by a measuring type gap that was approximately half way in the subsequent move. The big trends were over when reversal type breakaway gaps broke in the opposite direction, 'signaling' a possible REVERSAL.
A measuring 'gap' that appears after an initial and substantial advance may be an UPSIDE measuring gap, suggesting that the advance is approximately half way to an ultimate upside objective.
A measuring gap that appears after an initial and substantial downswing may be a DOWNSIDE measuring gap, suggesting the decline is about half way toward an ultimate or interim downside objective.
In the case of either such an upside or downside price gap, its of course going to be useful to have some measure of how far a move may extend.
GOOD TRADING SUCCESS!