Learning to trade opening gaps is one type of stock trading strategy that many traders wind up looking into and trying, at one point or another in their journey.
Since stock trading has an “excitement” factor about it already, opening gaps add even more excitement on top (no pun intended). This is one of the things that initially attract traders.
Because “excitement” is an emotion, trading with this type of strategy often leads to quick losses while lessons are being learned. While all trading strategies have some emotions involved, gaps occur from extreme measures of excitement when traders rush to get in, not wanting to be left behind.
What happens in many cases though, is that as new traders are rushing to get in and buying, bid prices move up dramatically. This causes the “gap” where prices open considerably higher due to the line of buyers waiting to have their orders filled.
As the line is forming from excitement, professional traders see what’s going on and look for an opportunity to take advantage of unknowing newcomers, or latecomers. As prices gap open, the professionals begin selling to the long line of “newbies” who already have their orders in. The professionals lock in profits, selling at the high, and the new shareholders are left with shares they purchased at the high, now becoming “bag holders”.
If enough selling occurs, this opening gap does indeed become the high for the day, and prices continue lower, many times to the price level from the previous day, closing the initial gap. When prices gap higher at the open like this and move lower, and continue lower for the day and the following days, this gap that occurred becomes what is known as an “Exhaustion Gap”.
Traders who are “Momentum Traders”, may not necessarily use these Gaps as an opportunity to buy, but instead, look at them as opportunities to sell since an Exhaustion Gap signals a reversal of some degree from the previous trend.
If you are serious about learning how to trade “Opening Gaps” and “Exhaustion Gaps”, you’ll want to learn about support and resistance levels, pivot points and analyzing news that comes out among other things. Once you understand the reason for the Gap itself, you’ll become more successful at figuring out when to trade, when not to trade and where to set stop losses to minimize potential losses, just in case.
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