The Daily Gap Trading Strategy is a popular approach used by traders to capitalise on the gaps that appear at the market open, particularly when the gap occurs between the previous day’s close and the next day’s open. This strategy can be applied to stocks, forex, and commodities, as well as indices, and aims to take advantage of gap filling or gap continuation.

This strategy is ideal for day traders and swing traders who want to make use of the price imbalances that occur after market closures, typically looking for a short-term reversal or continuation depending on the type of gap.

What Is a Daily Gap?

A daily gap occurs when the price at the market open is significantly different from the previous day’s close. Gaps can be classified into three types:

1. Common Gaps: Small gaps with no major news or catalysts behind them. These gaps usually fill quickly and are part of normal market fluctuations.
2. Breakaway Gaps: Large gaps that occur at the start of a new trend, usually after a consolidation or pattern breakout.
3. Exhaustion Gaps: Gaps that happen at the end of a trend, signaling that the trend is likely to reverse.

The Daily Gap Trading Strategy focuses primarily on common gaps and sometimes breakaway gaps, depending on the broader market context.

Why This Strategy Works

• Gaps reflect overnight sentiment and market overreaction, often creating price imbalances that can be exploited.
• Price gaps tend to either fill (move back to the previous close) or continue in the direction of the gap if supported by momentum.
• Gap-filling occurs because the market often wants to correct the price after such imbalances, whereas gap continuation occurs when there’s strong momentum behind the move.
• Gaps that occur with high volume or strong catalysts often have higher continuation potential, while smaller gaps are more likely to fill.

How to Trade the Daily Gap Strategy

1. Identify the Gap

The first step is to identify the type of gap:

• Check for a gap of at least 0.5% – 1% from the previous day’s close.
• Confirm the gap type (Common, Breakaway, Exhaustion):
  • Common gaps are typically small and appear without major news.
  • Breakaway gaps come with high volume and are usually at the beginning of a trend.
  • Exhaustion gaps are typically seen after a large price run-up or run-down.

2. Decide on a Gap Filling or Continuation Setup

• Gap Fill (Reversal):
  • This is the most common scenario for small common gaps.
  • Look for price rejection candles such as pin bars, engulfing candles, or doji candles at the gap’s extreme.
  • Enter when price begins to revert towards the previous day’s close.
• Gap Continuation (Breakaway):
  • If the gap is large and volume confirms a strong trend (e.g., earnings report or news), this could be a breakaway gap.
  • Look for a small pullback or consolidation within the first 30 minutes of the trading session and enter when price breaks the previous high/low.
  • Use the previous high/low as a stop-loss for these setups.

3. Entry Confirmation

For Gap Fill (Reversal):

• Look for price to reverse from the gap and show a clear rejection (such as a pin bar or engulfing candle at the gap high or low).
• RSI: Look for RSI divergence or an overbought/oversold reading (above 70 or below 30) to confirm a potential reversal.
• Volume: Ensure that the volume is fading as the gap fills, confirming the lack of momentum to continue the gap.

For Gap Continuation (Breakaway):

• Look for price to continue in the same direction of the gap.
• A small consolidation or pullback after the gap opens can be an opportunity for new entries.
• Enter on the breakout of consolidation with high volume confirming momentum.

4. Stop-Loss and Take-Profit

Stop-Loss:

• For gap fill setups, place the stop-loss just beyond the gap extreme (just above the high for short trades, or below the low for long trades).
• For gap continuation setups, place the stop-loss just below the gap low (for long positions) or above the gap high (for short positions).

Take-Profit:

• For gap fill: Target the previous day’s close or key support/resistance levels.
• For gap continuation: Use Fibonacci extensions (127.2%, 161.8%) or measure the distance of the gap and project it forward.

5. Risk Management and Trade Management

• Use a 1:2 risk-to-reward ratio as a minimum.
• Partially exit at key levels or adjust the stop to breakeven once the gap has moved in your favour.
• Monitor volume closely—for gaps to continue, the momentum and volume should remain strong.
• Avoid chasing gaps—wait for price confirmation and avoid entering if price moves too far from the opening gap.

Strategy Summary Table

Component	Details
Gap Type	Common Gap (small) or Breakaway Gap (large with volume)
Setup Type	Gap Fill (Reversal) or Gap Continuation (Breakaway)
Entry Trigger	Reversal candle (gap fill) or breakout after consolidation (gap continuation)
Stop-Loss	Beyond gap high/low or recent swing level
Take-Profit	Previous day’s close, support/resistance, Fibonacci extension
Timeframe	5M–15M for entry; 1H–4H for trend confirmation
Best Use Case	Stocks, forex, indices after overnight news or earnings

Example: Gap Continuation on Apple (AAPL)

• Apple’s stock opens 2% higher due to better-than-expected earnings.
• The gap holds above a key resistance level (the previous day’s high).
• The stock consolidates for 15 minutes, and then breaks out to the upside on increased volume.
• Trader enters long with a stop just below the breakout level.
• Apple rallies an additional 5%, and the trader profits from the continuation.

Conclusion: Profit from Price Imbalances with the Daily Gap Strategy

The Daily Gap Trading Strategy offers traders a systematic way to profit from overnight price imbalances. Whether you are fading gaps or riding them in the direction of the trend, this strategy provides clear entry points, risk management, and potential for strong short-term profits.

To refine your gap trading skills and integrate them into a complete trading strategy, enrol in our Trading Courses at Traders MBA and elevate your understanding of market openings and price action.