Mind the Stock Gap or Lose Your Shirt

A stock gap occurs when a stock opens at a higher or lower price than it closed the previous day. These gaps usually occur because there were a large number of buy or sell orders put in between the close of one day and the start of trading the next. So, you might wake up to the happy coincidence that your stock is worth more than it was the day before, of course, it could be, you find your stock suddenly plummeting out of control.

A stock gap will appear as an actual space in the bar of the trading chart. Gaps are normal and happen all the time, but they can also indicate important, or long term changes in a stock's value. If you track the stock carefully you can often anticipate the gaps. It is also a good idea to research the company thoroughly. This information will prepare you for fluctuations that are a normal part of doing business and when there really is something that warrants concern. Many gaps are panic driven, understanding the underlying situation will help you stay in control and can show you how to exploit the gap. Below are some different types of gaps and what can cause them.

The Common Gap

The common gap indicates a coincidence in normal trading and will right itself quickly. They are usually small, and of short duration.

The Breakaway Gap

This is a large gap in which a stock's price significantly changes, either up or down, over night. This sort of change is caused by extreme optimism or pessimism and can be spurred by things like earnings reports that are unexpectedly positive or negative. It can also be caused by traders reading buying or selling signals in common gap trends. 

The Runaway Gap

These gaps are significant. They are usually caused by investors perceiving that a stock's value is rapidly changing. They may be trying to jump on board a rising stock, or trying to dump a stock they feel is crashing.

The Exhaustion Gap

This gap is almost always seen after a stock has been heavily traded. At this point, traders usually want in or out of the stock at any price. It generally indicates a reversal or the end of a trend, and so will mark the high or low point of trading.

Many gaps are caused by investors whose decisions are based on emotion. By trying to get in on a rising stock or get rid of a falling one, they can create a self fulfilling prophesy. Any of these gaps can indicate positive trading signals. Remember, you need to buy when the stock begins its up turn or sell before the down turn, don't try to chase the stock. If you are patient and wait until you can anticipate the trend accurately, gaps can be an excellent trading environment. If you let your emotions get the better of you and buy or sell out of panic, it is very easy to lose your shirt.

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