First, how is the gap formed?

A stock price gap refers to the price gap area on the chart where no trading occurs during a certain period of time.

In terms of daily charts, the generation of a gap is usually due to significant changes in market sentiment after the close of the day and before the opening of the next day, leading to an imbalance in supply and demand.

For example, if a company releases bullish earnings reports after the close, causing many investors to believe that its stock is undervalued, this may lead to the opening price the next day directly exceeding the previous day's highest price, thus creating a 'gapping up' gap.

A closely related concept to the gap is called 'gap filling.' This refers to the stock price returning to the gap area after the gap forms, thereby filling the price gap area on the chart. It is often heard in the market that 'gaps will always be filled.' In fact, this is an unfounded and biased statement that is easily misleading.

In order to better understand the formation of gaps and their subsequent dynamics, gaps are generally classified into four types in technical analysis.

Second, what is a common gap?

The first type is the common gap. As the name suggests, a common gap is very common and is the most common type of gap in the market.

Generally speaking, common gaps are naturally formed and not driven by specific events. Therefore, common gaps are often small and do not have much analytical significance.

Compared to other types of gaps, common gaps are usually filled quickly. In other words, some traders may exploit potential gap fills to discover trading opportunities.

For example, stock A jumps to a higher opening price of $100.1, slightly above the previous day's high of $100. If there is no obvious bullish driver behind the gap, then this small gap above $100 is likely to be filled in the coming days, or even on the same day.

3. What is a Breakaway Gap?

The second type is a breakaway gap. For many traders, a breakaway gap may be the most exciting as it often indicates the start of a major market move.

As the name suggests, a breakaway gap is a gap that occurs as the stock price breaks through a certain trading range, for example, when certain chart patterns are finally formed, or when the stock price breaks through the major trendlines.

When significant events occur in the market, such as the release of earnings reports by listed companies, it is easy to create a breakaway gap. When breakaway gaps occur, there is often a significant increase in volume. This is because market participants increase significantly. Apart from chasing rallies and selling off, there are investors who may have misjudged the direction before the stock price breaks through, and they may choose to adjust their positions.

Breakaway gaps are generally not filled in the short term. But it is worth noting that the ideal closing price of a breakaway gap is usually close to the intraday high or low, implying that the stock price still has some upward or downward momentum at the close. Conversely, if there are significant flaws in the closing price of the breakaway gap, investors may need to be more cautious about this so-called 'breakaway'.

What is a continuation gap?

The third type is a continuation gap. The continuation gap occurs as the market develops and investor interest increases.

In theory, some technical analysts believe that continuation gaps often occur after a breakaway gap.

The underlying logic behind the formation of a continuation gap is that some investors, initially hesitant to participate in the market at the start, intended to wait for a price pullback before entering the market. However, at a certain point, their interest suddenly rises significantly, leading them to enter the market without waiting for a pullback.

What triggers investors' interest is often some unexpected events, such as a listed company releasing new products, better-than-expected earnings reports, or announcements of mergers and acquisitions.

In an uptrend, a continuation gap suggests that the market may continue to strengthen; in a downtrend, a continuation gap suggests that the market may continue to weaken.

When the trend is particularly strong, continuation gaps may appear one after another, typically indicating further consolidation of the trend.

Continuation gaps usually are not filled in the short term. Additionally, continuation gaps are often accompanied by an increase in volume, indicating investors' recognition of the current trend.

What is an exhaustion gap?

The last type is the exhaustion gap. The exhaustion gap appears when the market trend is approaching the end, and is often the first signal that the trend is about to end.

The exhaustion gap is usually accompanied by a huge volume. However, due to a large amount of profit-taking by investors, coupled with gradually declining demand, the trend at this point is basically difficult to sustain.

From the trader's perspective, if breakthrough gaps and continuation gaps have been successively discovered in a trend market, one should consider the possibility of an exhaustion gap appearing in the market at some point in the future.

Many people easily confuse exhaustion gaps with continuation gaps, as there are indeed some similarities between the two. Exhaustion gaps often come with extremely high trading volume, implying that panic sentiment is spreading in the market.

Generally, exhaustion gaps are quickly filled because when exhaustion gaps appear, the market may soon experience a reversal.