Gaps on the chart

After this lesson you can classify a gap by its context, and you'll know which folklore about gaps to ignore.

The hole in the chart

School II, course 6 showed you the gap from the risk side: the overnight repricing that no stop can trade through. On the chart it appears as a hole — today's candle beginning far from yesterday's close, with untraded air between them. This course reads that hole as information.

A gap is the visible record of a surprise (School I, course 8): something changed while the market was closed, and the opening auction priced it all at once. The size of the gap measures the size of the surprise. What the gap means, though, depends almost entirely on where in the story it happens, and the classical taxonomy (from the pattern literature going back to Edwards and Magee) sorts them by exactly that.

The breakaway gap. Out of a long base (course 3), often on earnings, usually on enormous volume. The stock leaves its base in a single session, and the chart carries a hole where no trading happened. Gaps like this one tend to start moves. The repricing is the market conceding, in one auction, that the company's situation has changed, and School IV's model-book course will show you how many of history's big advances began with precisely this event.

The continuation gap. Mid-advance, in the direction of the trend, on news that confirms the thesis. The trend, already running, gets fresh fuel.

The exhaustion gap. Late in a long advance, and often the most spectacular-looking of the lot: a huge leap after months of gains, on frantic volume. Then within days the move dies. The last urgent buyers all bought at once, and there's nobody behind them. Distinguishing continuation from exhaustion in real time is genuinely hard; the honest markers are how far the advance has already run and what happens in the sessions right after (a gap that immediately gives its gains back is a bad sign).

The common gap. Small, on no news, in quiet ranges, closed within days and meaning nothing. Most gaps are these.

The folklore

"Gaps always fill" — meaning price always returns to close the hole — is the most repeated gap statement in trading, and as a rule it's worthless. Common gaps fill quickly because nothing caused them. Breakaway gaps from real surprises may stay open for years; the best ones never fill, because the repricing was correct. So the rule works only on the gaps that never mattered in the first place, which makes it useless for trading. School VIII will hand you the tools to check claims like this one yourself.

The practical stance pulls from both schools that have touched gaps. On the risk side, respect them: know your event dates, and size for the possibility. When you're reading a chart, ask where in the story the gap sits, out of a base or mid-trend or after a long run.

Check yourself

1. A stock breaks out of an eight-month base with a +12% gap on five times average volume. Classify it, and say what the volume adds. (Breakaway. The volume says real size committed at the new prices — the base's resolution came with evidence.)
2. After a 140% advance over a year, the same stock gaps up 9% and closes near its low, giving most of it back. What's the concern? (Exhaustion behaviour — a spectacular leap that immediately fails is the classic sign the last buyers just bought.)
3. Why is "gaps always fill" useless as a trading rule? (It holds for the gaps that never meant anything. The ones that mattered were correct repricings, and those never come back.)

The idea this lesson installs

A gap's meaning comes from where in the story it happens.

Next: Course 8 — "Patterns, honestly."