The conventional wisdom in day trading when it comes to trading gaps is often summarized by the phrase “gaps tend to fill.” This means that when a stock opens at a price significantly different from its previous close, creating a “gap,” there’s a tendency for the stock to reverse direction and “fill” the gap by returning to its previous closing price.
Here are some common gap trading strategies based on this conventional wisdom:
- Gap and Go: Traders buy the stock at the opening price with the expectation that the gap will propel the stock even higher. This strategy works best when the gap is backed by strong fundamentals or news catalysts.
- Fade the Gap: This strategy involves shorting the stock with the expectation that the gap will fill at some point during the day. This is often used when the gap appears to be caused by emotional or irrational trading at the market open.
- Partial Gap Fill: Some traders aim for a partial fill of the gap, taking profits before the stock reaches its previous close. This is a more conservative approach.
- Gap Continuation: In this strategy, traders wait for the stock to fill the gap and then continue in the direction of the gap, expecting a new trend to form.
It’s important to note that while gaps often fill, they don’t always do so immediately. Timing, market sentiment, and the underlying reasons for the gap (like earnings reports or news events) can all influence whether and when a gap fills.
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