Gap Openings: Reversals and Continuations
A gap opening on any time frame means that once the bar in question closes, it does not overlap the bar before it. On most days, there are gap openings on the 5 minute chart. They can be thought of as simple breakouts since the market broke out of the final bar of the prior day. They should be traded like any other breakout except traders know that large gaps increase the chance that the day will become a trend day. The larger the gap, the more likely the day will be a trend day and the more likely the gap will function as a spike and be followed by a trending channel in the same direction. For example, a large gap up has perhaps a 50 percent chance of being followed by a bull channel, a 20 percent chance of being followed by a trading range, and a 30 percent chance of being followed by a bear trend. These probabilities are only guidelines because using computer testing to find exact numbers is subject to too many variables. How big does a gap have to be to be thought of as large? How much of a rally after the gap up constitutes a channel instead of just a slightly upward-sloping trading range? How much of a sell-off constitutes a reversal compared to just a deep pullback? As another guideline, if the gap is the largest gap of the past five days or so, or if it is larger than about half of the average daily range, it can be considered to be a large gap.
A large gap opening on the 5 minute chart from yesterday's close represents ...