Quick Gains from "Gapping" Stocks

When Stocks "Gap" Higher or Lower, It May Be Time to Make a Trade

Stock Charts and Prices on Sidewalk
Stock Market Images on Street. Hiroshi Watanabe

When shares of a stock start trading at a lower price than they closed the previous day, that is known as a "gap down." For example, picture a stock which closed Tuesday at $4.50, then started trading on Wednesday at $3.50. That would be a significant gap down of $1 per share.

Stocks can "gap up" as well. Regardless of the direction of the move, gaping represents some very significant implications, and by extension, just as significant opportunities.

However, gapping up and gapping down each have very different implications for the underlying stock.

Gap Down:  

Gap downs are useful technical indicators for finding shares which may rebound or change the direction of their overall trend. This is especially true for stocks which have been sliding lower over days and weeks, then suddenly take a gap down step lower.

Typically such a scenario may indicate capitulation, whereby investors are just fed up and dump their shares en masse. The selling pressure overwhelms any buying demand.

The gap down also acts to hasten seller exhaustion. There comes a point where there aren't any traders left to sell, or any investor who wanted to get rid of their shares has done so.  

In addition, any gap down can set the shares in deeply undervalued levels. Since the move can be a sudden drop, the valuation can often suddenly look pretty compelling.

The scenario, indicated by the gap down, often precedes a recovery in the shares.

It also may mark the bottom of the downward trend, and thus also establish the beginning of what will be the coming upward move. From gap down to the rebounding upward move typically only takes one day to begin.

Gap Up:

In many cases, but not all, especially coming after a long sustained move higher for the stock, a gap up may imply the end of the uptrend.

Think of it almost like one last burst of buying near the end of the rise of the shares, at which point everyone who wants to get in on the investment has now done so.

The gap may also be partially caused by a lack of sellers, which further reasons as to why the buying up to this point has resulted in the move higher for the shares over the preceding days or even weeks.

The gap up is causing two reactions at once:

1. The gap up is putting the stock at a suddenly higher share price, which will finally encourage some sellers and profit-takers.

2. The gap up is a mini-stampede to get into the stock, which in turn leads to the fulfillment of the buyers' trades, subsequently leaving few or no buyers.

While a gap up can often be the beginning of a move higher for the shares, especially if it was based on some fundamental event for the underlying company, it more likely represents the top of an uptrend and the final days of positive momentum.

Important Note: Gapping is not the same as a share price "falling off a cliff," whereby some negative news or event has sunk the stock from much higher prices. Any time there is an underlying reason for the fall lower (or rise higher, in the case of gapping up), then the theories discussed here are less applicable.