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Bollinger Band Strategies Fair Value Gap Trading Strategy
6 mins read

Gap Fill Trading Strategies

Gap fill trading strategies are a popular approach among traders looking to capitalize on sudden price movements in the financial markets. These strategies involve identifying gaps in price charts caused by overnight news or other market-moving events and then buying or selling positions to take advantage of the price movements that occur as those gaps are filled.

In this article, we will explore the basics of gap fill trading strategies, how they work, and the risks and rewards involved in using them. We will also examine some popular gap fill trading techniques and provide tips for successfully incorporating them into your trading strategy. Whether you’re an experienced trader or just getting started, understanding gap fill trading strategies can be a valuable tool for profiting in the markets.

What Is a Gap?

A gap is a technical analysis term used to describe a price movement where a financial instrument’s price opens higher or lower than its previous closing price. Trading gaps occur when there is a significant change in the supply or demand for an asset, and this results in a sudden jump in price.

Gaps can occur due to various reasons, such as significant news or events, changes in market sentiment, or changes in the underlying fundamentals of the asset. For example, a company announcing better-than-expected earnings results can cause a gap up in its stock price, while negative news such as a major lawsuit or a market crash can cause a gap down. Gaps can also occur due to technical factors such as stop-loss orders or margin calls.

What Is a Gap Fill?

Gap fill refers to a price movement where the price of a financial instrument moves back to the level it was at before the gap occurred. In other words, gap fill is when the price “fills in” the gap by retracing back to its previous level.

Some of the reasons why gaps fill include:

  1. Overreaction: Sometimes, a gap may occur due to an overreaction to news or events. As the market digests the news, traders may realize that the impact is not as significant as previously thought, causing the price to revert back to its previous level.
  2. Profit taking: Traders who bought a financial instrument at a lower price during the gap may sell when the price reaches their target, causing the price to fall back to its previous level.
  3. Technical levels: Traders often use technical levels such as support and resistance to make trading decisions. If a gap occurs above a significant resistance level, traders may take short positions, pushing the price back down to the resistance level.
  4. Market sentiment: Gaps can sometimes occur due to a sudden change in market sentiment. If this change is short-lived, traders may quickly take advantage of the price movement, causing the price to revert back to its previous level.

It’s important to note that not all gaps fill, and some may take a longer time to fill than others.

Types of Gaps

To effectively execute a gap fill trading strategy, it’s important to have a good understanding of the different types of gaps and how to identify them. Knowing the type of gap you are dealing with can help you determine the probability of the gap being filled and the appropriate trading approach to take. The four types of gaps are:

  1. Common Gaps: These gaps occur frequently in the market and are typically small in size. They usually occur within a well-defined price range and are often accompanied by low trading volumes. Common gaps are more likely to be filled than other types of gaps as they are often caused by normal price fluctuations.
  2. Breakaway Gaps: These gaps occur when a stock or other asset price breaks out of a trading range, indicating a significant shift in market sentiment or trend direction. Breakaway gaps are larger than common gaps and are often accompanied by high trading volumes. These gaps are less likely to be filled as they indicate a strong momentum in the market and can be an early indication of a new trend or market movement.
  3. Runaway Gaps: These gaps occur in the middle of a strong trend and indicate a continuation of the existing trend. Runaway gaps are often associated with high trading volumes and significant price movements. These gaps are less likely to be filled as they indicate a strong momentum in the market and can signal a continuation of the current trend.
  4. Exhaustion Gaps: These gaps occur at the end of a trend and are typically smaller than breakaway or runaway gaps. They are often associated with high trading volumes, indicating a sudden increase in market activity and a possible change in market sentiment. Exhaustion gaps are more likely to be filled than breakaway or runaway gaps.

Understanding the characteristics of each type of gap can help traders determine the likelihood of a gap being filled and make more informed trading decisions.

Gap Fill Trading Strategies

In addition to identifying the type of gap, traders should consider several other factors when developing a gap fill trading strategy. Here are some other things to consider:

  1. Volume and liquidity: Traders should consider the volume and liquidity of the security they are trading. A security with high volume and liquidity is more likely to have a smoother gap fill as there will be more participants trading it.
  2. Market trend: The market trend is an important factor to consider when developing a gap fill strategy. If the market is trending strongly, the gap may not fill as quickly or may not fill at all. On the other hand, if the market is moving sideways or in a range, the gap is more likely to fill.
  3. Time frame: The time frame of the gap can affect the trading strategy. For example, a gap that occurs on a daily chart may take longer to fill than one that occurs on an hourly chart. Traders should consider the time frame they are trading and adjust their strategy accordingly.
  4. Technical analysis: Traders can also use technical analysis to identify key levels of support and resistance that may impact the price action of the security during a gap fill. These levels can be used to determine entry and exit points for the trade.
  5. Fundamental analysis: Fundamental analysis can also be useful in developing a gap fill strategy. Traders can look at earnings reports, economic data, and other news events that may affect the market to help identify potential gaps that are likely to fill.
  6. Risk management: Trading gap fills can be risky, and traders should have a solid risk management plan in place. This can include setting stop-loss orders, using position sizing to limit exposure, and being disciplined in adhering to their trading plan.

By considering these factors, traders can develop a more comprehensive gap fill trading strategy and increase their chances of success.

Pros and Cons of Gap Fill Trading

Here are some potential pros and cons of using this type of trading gap fills:

Pros:

  1. Potential for high profits: Gap fill trading strategies can offer high-profit potential, as the gap can be significant and may offer an opportunity to capture a quick profit.
  2. Easy to identify: Gaps in price are easy to identify on a price chart, making it simple to spot potential trading opportunities.
  3. Can be used with a variety of assets: Gap fill trading strategies can be used with a wide range of assets, including stocks, commodities, and currencies.

Cons:

  1. High risk: Trading based on gaps in price can be risky, as there is no guarantee that the gap will be filled quickly or at all.
  2. Can be unpredictable: Gaps in price can be caused by a variety of factors, including news events and market sentiment, making it difficult to predict when and how they will be filled.
  3. Requires quick action: Traders must act quickly to capitalize on gaps in price, as they may close rapidly, leaving little time to execute trades.

Overall, gap fill trading can be potentially lucrative but carry significant risk and require careful consideration and execution.

Example scanners and strategies that use Gap Fill

Gap Fill can be used in both Scanning the market and Testing Strategies. To see how exactly it can be used in these ways, we provide the following samples. The scanner searches the market for stocks using this indicator, and the strategy tests buying and selling rules built around this indicator.

"Gap Up On Volume Today #Jason" scanner by TrendSpider
charts.trendspider.com
“Gap Up On Volume Today #Jason” scanner by TrendSpider

The Bottom Line

In conclusion, gap fill trading strategies can be a valuable tool for traders seeking to profit from sudden market movements. By identifying gaps in price charts and taking advantage of subsequent price movements, traders can potentially earn significant returns on their investments. However, gap fill strategies also carry risks, as sudden price movements can be unpredictable and difficult to forecast. Therefore, it is important for traders to have a solid understanding of the market and a clear strategy in place before engaging in gap fill trading.

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Bollinger Band Strategies Fair Value Gap Trading Strategy