Understanding Gaps: Breakaway, Normal, and Exhaustion Gaps 

Content Details 

• Summary: This article explains the different types of gaps in trading: breakaway gaps, normal gaps, and exhaustion gaps. It highlights the importance of distinguishing between these types of gaps to avoid making incorrect assumptions about whether a gap will be closed. 

• Target Audience: Intermediate to advanced traders who want to understand the significance of different types of gaps and how to interpret them for informed trading decisions. 

Expanded Response for Trading Hub Analytics 

Quote: "Don't count on gaps being closed unless you can distinguish between breakaway gaps, normal gaps and exhaustion gaps." 

Expanded Response: 

• Definition: Gaps occur when there is a significant difference between the closing price of one period and the opening price of the next period, resulting in a space or "gap" on the price chart. Understanding the different types of gaps—breakaway, normal, and exhaustion—is crucial for making informed trading decisions. 

Types of Gaps: 

Breakaway Gaps: 

• Description: These gaps occur at the beginning of a new trend, often accompanied by high volume. 

• Significance: They indicate a strong move in the direction of the gap and are less likely to be filled quickly. 

Normal (Common) Gaps: 

• Description: These gaps occur within the context of a trend, typically during periods of low trading volume. 

• Significance: They are the most common type of gap and are usually filled relatively quickly. 

Exhaustion Gaps: 

• Description: These gaps occur near the end of a trend, often after a significant price movement, and are usually accompanied by a spike in volume. 

• Significance: They signal the potential end of the current trend and are more likely to be filled. 

Stages: 

• Identify the Gap: Determine if a gap has occurred by comparing the closing price of one period to the opening price of the next. 

• Classify the Gap: Use the characteristics of each gap type to classify the gap as breakaway, normal, or exhaustion. 

• Analyze Volume and Context: Examine trading volume and the overall market context to confirm the gap type and its implications. 

• Develop a Trading Strategy: Based on the gap type, decide on a trading strategy that accounts for the likelihood of the gap being filled. 

• Example in SPX: Suppose SPX has a significant upward breakaway gap accompanied by high volume at the start of a new uptrend. Traders should recognize this as a breakaway gap, indicating a strong move upward with a low likelihood of being filled soon. Conversely, if SPX shows an exhaustion gap near the end of a prolonged uptrend with high volume, traders should anticipate a potential reversal and the likelihood of the gap being filled. 

• Practical Application: 

Trading Strategy: 

• Identify and Classify: Quickly identify gaps and classify them accurately to understand their implications. 

• Volume Analysis: Use volume indicators to confirm the type of gap and its significance. 

• Set Alerts: Configure alerts for gap formations to respond promptly with appropriate trading actions. 

• Position Management: Adjust positions based on the type of gap. For example, hold positions during breakaway gaps and consider exiting or reversing positions during exhaustion gaps. 

Risks: 

• Misclassification: Incorrectly classifying a gap can lead to poor trading decisions. 

• Market Volatility: Rapid market changes can affect the likelihood of gaps being filled, requiring flexible strategy adjustments. 

Indicators for Enhancing Gap Analysis: 

• Volume Indicators: Confirm the significance of gaps with volume spikes. 

• Moving Averages: Use moving averages to provide context and identify the trend direction. 

• Relative Strength Index (RSI): Gauge overbought or oversold conditions near gap formations. 

• Candlestick Patterns: Look for candlestick patterns that confirm or negate the gap's implications.