DEFINITION of 'Gapping'

Gapping is when a stock opens significantly above or below the previous day’s close with no trading activity in between. Partial gapping occurs when the opening price is higher or lower than the previous day’s close but within the previous day’s range. Full gapping occurs when the open is outside of the previous day’s range.

                                                   Gapping Example

Image depicting a gapping example.

Gapping may also refer to a trading strategy in which the participant borrows short and lends long. This strategy gives the lender an overall better interest rate as short rates are usually lower than long rates.

BREAKING DOWN 'Gapping'

Gapping is clearly visible on a price chart and interpreted as a trading opportunity due to increased volatility and interest in the stock. Typically, traders look for gaps that are at least 5% above or below the previous day’s close. Day traders either trade in the direction of the gap or fade the gap. In general, if the price goes up, it signals a buy, and if it goes down, a short. There are several variations of the gap strategy. Traders can use intraday and end-of-day stock market scanning software to find the best gapping candidates to trade.

Gapping and Stop Loss Orders

A trader can have a stop-loss order filled significantly below his or her stop-loss price (for a long position) due to gapping. For example, a trader may buy a stock on the close at $50 and place a stop-loss order at $45. The next day before the market opens, the company issues an unexpected profit warning, and the stock opens at $38. The trader’s stop-loss order now becomes a market order, because the stock’s price is below $45, and gets filled at the best available price; most likely close to $38. Traders can reduce gapping risk by not trading directly before company earnings and news announcements that are likely to have a material impact on a stock’s price. During periods of high volatility, reducing position size helps to minimize losses caused by gapping.

Gapping Trading Strategies

  • Buying the Gap: Day traders often refer to this strategy as the "gap and go." A position could be taken on the day the stock gaps with a stop-loss order usually placed beneath the low of the gap bar. The gap should occur above a significant resistance level and trade on heavy volume to increase the chances of a profitable trade. Alternatively, traders could wait for prices to fill the gap and place a limit order to buy the stock at the previous day's close.                                                                                                                                                                     
  • Selling the Gap: Contrarians may use a fading strategy to exploit gapping. Traders could take a short position on the premise that most gaps close. A stop-loss order is placed above the gap bar’s high with a profit target set at the previous day’s close. To increase the probability of a successful trade, the high of the gap bar should be near overhead resistance, such as close to a moving average or a round number. (For more, see: Playing the Gap.)
RELATED TERMS
  1. Gap

    A break between prices on a chart that occurs when the price ...
  2. Gap Risk

    Gap risk refers to a security’s price changing from one level ...
  3. Breakaway Gap

    A breakaway gap is a term used in technical analysis which identifies ...
  4. Gap Analysis

    1) The process through which a company compares its actual performance ...
  5. Runaway Gap

    A type of gap on a price chart that occurs during strong bull ...
  6. Island Reversal

    An occurrence in technical analysis where a stock price will ...
Related Articles
  1. Trading

    Playing the Gap

    Learn how you can earn money by analyzing the disruptions in normal price patterns.
  2. Trading

    Know How To Manage Gaps On Your Trading Strategy

    Gaps generate profitable strategies right after they print, as well as during retracements that test those levels, often months or years later.
  3. Trading

    3 Gap Trades On SP-500 Stocks (AMAT, NEM)

    Gaps generate all sorts of trading signals, both when they occur and when price pulls back to test or fill them.
  4. Trading

    Analyzing The Market With Trend Mirrors

    Past price action can exert a powerful influence on current rallies and selloffs.
  5. Investing

    Gap Plummets After Warning of Bleak First Quarter

    Shares of Gap (NYSE: GPS) fell nearly 12% on Tuesday after the apparel retailer warned that its first-quarter sales and earnings would broadly miss analyst estimates. Gap said it generated $3.44 ...
  6. Investing

    Investors Overlooking 'Powerhouse' Old Navy: Jefferies

    Gap Inc.’s recent stock rally has much further to run as investors have yet to fully appreciate the exciting earnings potential of the clothing giant’s apparel chain Old Navy, according to analysts ...
  7. Trading

    High-Volume Breakouts Signal A Move Higher

    Traders will keep an eye on these high-volume events to see if they trigger a new uptrend.
  8. Insurance

    Do Drivers Really Need Gap Insurance?

    Gap insurance is worth it for drivers who are significantly upside-down on their car loan. That includes lessees and buyers with a small down payment.
  9. Investing

    The UK Has Fined PFE For Unfair Drug Pricing (PFE)

    The company was fined for its unfair practices and pricing.
  10. Investing

    Old Navy Boosts Gap: Is a Turnaround Likely? (GPS)

    Thanks to Old Navy Gap's June comps came in strong. How likely is a turnaround?
RELATED FAQS
  1. What are the main differences between a Runaway Gap and a Exhaustion Gap?

    Discover the primary differences between runaway and exhaustion gaps, and see why gap differentiation depends on subsequent ... Read Answer >>
  2. How do I place a stop loss order?

    Learn how to place a stop-loss order and how traders use stop orders to either limit potential losses or to protect part ... Read Answer >>
  3. What is the difference between a buy limit and a stop order?

    Learn the difference between buy limit orders and stop orders, including stop loss orders, and understand the risks of the ... Read Answer >>
  4. How do I Implement a Forex Strategy when spotting a Sanku (Three Gaps) Pattern?

    Understand the significance of the sanku candlestick pattern, and learn a forex trading strategy to employ when recognizing ... Read Answer >>
  5. What are some ways to reduce downside risk when holding a long position?

    Learn about the various methods a trader can use to minimize risk of loss or protect a portion of profits in an existing ... Read Answer >>
Hot Definitions
  1. Treasury Yield

    Treasury yield is the return on investment, expressed as a percentage, on the U.S. government's debt obligations.
  2. Return on Assets - ROA

    Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets.
  3. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  4. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  5. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  6. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
Trading Center