What are gaps, why do they occur, and how can you profit from them?
Posted by MC on Jun 12, 2008
What is a gap?
A gap is shown on the charts any time you have price open outside the prior time period’s high or low.
The below section will go into details on why gaps on big volume are significant and how you can take what I’m teaching and use it to recognize the psychology behind those moves. There will be small gaps or gaps on low to normal volume. These are events of no interest to us. It’s the gaps on abnormal volume that should catch your eye and make you want to know what they did that for. Bottom line…large volume is the pros at work, our job is to realize why they are moving that many shares and follow their lead.
Bigger notable Gaps are used for 2 purposes…
1) A breakaway gap moves fast and is used to eliminate concerns of supply slowing the run. The breakaway gap is used so they can accomplish 2 things. One is to lock OUT new shareholders from playing along because it’s “too high”. The 2nd thing is to lock IN people that are in the red, which avoids weak hands selling into their rally. This elimination of supply ensures a continued powerful move. This is generally done on a beat up play once big money have their fill of cheap shares. They could however use this to panic people into selling, using peoples greed against them on all time highs. The latter is a way the pros could buy high knowing they will soak up the float and sell higher. This is very rare in my experience however, pros don’t like to pay a premium.
(HINT) Look for any pullbacks to be UBER light volume if it’s a legit breakaway gap. This could be played by trying to get in as close to the low of the gap as possible to ensure a tight stop.
2) Any other gap would be used by pros to hide their own supply trail. These gaps would create early excitement as well, but in this case to sucker unsuspecting traders in.
(HINT) This type of gap tends to have the next day close lower on fairly big volume. Often you will see a retracement and then a test of the prior highs on UBER light volume showing the professional money has no interest at paying the current price. A downtrend commences till the pro money buys back in. This could be played waiting for that test of highs and then fading the move once volume ticks up showing emotional trading.
Here’s a good example of a short I called using a weak gap. It was a HUGE gap so “how could that be weakness”. I was told I was crazy for thinking of shorting, despite telling people to wait for the breakdown. Sometimes you need to be cautious no matter how bullish it may seem. 
Enjoy, good trading. 
