Gap Trading
Gap trading focuses on price gaps between sessions and aims to profit from gap continuation or gap fill. Gaps are common around earnings, macro announcements, and overnight news.
Types of Gaps
Common gaps occur within normal volatility and often fill quickly. Breakaway gaps signal the start of a new trend. Exhaustion gaps occur near the end of a trend and may reverse soon after.
Strategy Approaches
Continuation strategies trade in the direction of the gap when volume confirms strength. Gap fill strategies fade the move and look for a return to the prior close. Each approach requires different risk controls and timing rules.
Risk Management
Gaps can move rapidly, and spreads may widen around the open. Stop placement must account for volatility and the risk of further gaps. Liquidity can be thin in the first minutes of trading.
Conclusion
Gap trading can be profitable but is highly sensitive to execution and news flow. Clear rules and strict risk limits are essential.
Practical checklist
- Define the time horizon for Gap Trading and the market context.
- Identify the data inputs you trust, such as price, volume, or schedule dates.
- Write a clear entry and exit rule before committing capital.
- Size the position so a single error does not damage the account.
- Document the result to improve repeatability.
Common pitfalls
- Treating Gap Trading as a standalone signal instead of context.
- Ignoring liquidity, spreads, and execution friction.
- Using a rule on a different timeframe than it was designed for.
- Overfitting a small sample of past examples.
- Assuming the same behavior in abnormal volatility.
Data and measurement
Good analysis starts with consistent data. For Gap Trading, confirm the data source, the time zone, and the sampling frequency. If the concept depends on settlement or schedule dates, align the calendar with the exchange rules. If it depends on price action, consider using adjusted data to handle corporate actions.
Risk management notes
Risk control is essential when applying Gap Trading. Define the maximum loss per trade, the total exposure across related positions, and the conditions that invalidate the idea. A plan for fast exits is useful when markets move sharply.
Variations and related terms
Many traders use Gap Trading alongside broader concepts such as trend analysis, volatility regimes, and liquidity conditions. Similar tools may exist with different names or slightly different definitions, so clear documentation prevents confusion.
Practical checklist
- Define the time horizon for Gap Trading and the market context.
- Identify the data inputs you trust, such as price, volume, or schedule dates.
- Write a clear entry and exit rule before committing capital.
- Size the position so a single error does not damage the account.
- Document the result to improve repeatability.
Common pitfalls
- Treating Gap Trading as a standalone signal instead of context.
- Ignoring liquidity, spreads, and execution friction.
- Using a rule on a different timeframe than it was designed for.
- Overfitting a small sample of past examples.
- Assuming the same behavior in abnormal volatility.
Data and measurement
Good analysis starts with consistent data. For Gap Trading, confirm the data source, the time zone, and the sampling frequency. If the concept depends on settlement or schedule dates, align the calendar with the exchange rules. If it depends on price action, consider using adjusted data to handle corporate actions.
Risk management notes
Risk control is essential when applying Gap Trading. Define the maximum loss per trade, the total exposure across related positions, and the conditions that invalidate the idea. A plan for fast exits is useful when markets move sharply.
Variations and related terms
Many traders use Gap Trading alongside broader concepts such as trend analysis, volatility regimes, and liquidity conditions. Similar tools may exist with different names or slightly different definitions, so clear documentation prevents confusion.
Practical checklist
- Define the time horizon for Gap Trading and the market context.
- Identify the data inputs you trust, such as price, volume, or schedule dates.
- Write a clear entry and exit rule before committing capital.
- Size the position so a single error does not damage the account.
- Document the result to improve repeatability.
Common pitfalls
- Treating Gap Trading as a standalone signal instead of context.
- Ignoring liquidity, spreads, and execution friction.
- Using a rule on a different timeframe than it was designed for.
- Overfitting a small sample of past examples.
- Assuming the same behavior in abnormal volatility.
Data and measurement
Good analysis starts with consistent data. For Gap Trading, confirm the data source, the time zone, and the sampling frequency. If the concept depends on settlement or schedule dates, align the calendar with the exchange rules. If it depends on price action, consider using adjusted data to handle corporate actions.