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High-Probability Trade Setups: A Chartist's Guide to Real-Time Trading by Tim Knight

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Chapter 13

Gaps

A gap in the price of a security takes place when there is a large amount of empty vertical space between price bars, representing a sudden (and usually unexpected) rise or fall in price. Many things can cause a price gap, such as surprisingly good earnings, surprisingly bad earnings, FDA approval (or disapproval) of an important drug at a pharmaceutical company, a takeover of a company, and so on. Usually, something has taken place between market sessions that compels much more buying and selling pressure than would be experienced by the same stock on an ordinary day.

This is one reason that, while stop-loss prices are very helpful, they are not a guarantee of safety. If you are long a stock you bought at $10, and you have a stop-loss at $9.99, you are not assured that, no matter what happens, any loss you experience will be miniscule. The company might announce that it has been fabricating its accounting for the past five years, and it opens the next day at a bid of $2, which is the price you'll probably get (if you're lucky). Such a shock-event would be a gap.

DEFINITION OF THE PATTERN

The simplest definition of a gap is a positive difference in price between one day's maximum value and the next day's minimum value (or vice versa). If Monday's highest price is $15 and Tuesday's low price is $16, that would be a gap. If Thursday's lowest price was $14 and Friday's highest price was $13.75, that would also be a gap (albeit a small one).

The gaps that concern us ...

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