Gap trading is a popular technique that aims to profit from price gaps that occur when the market opens at a significantly different price from the previous close. These gaps can be due to a variety of factors, such as earnings reports, economic news, geopolitical events, or market sentiment shifts. Traders use gap trading strategies to capitalise on the momentum or reversion that typically follows the gap.

Gap trading strategies can be applied to various asset classes, including stocks, forex, commodities, and indices. Traders can either look for gap fills (mean reversion) or gap continuation (momentum) based on the type of gap.

Types of Gaps

1. Common Gaps:
   • Small gaps that occur regularly and are often filled quickly.
   • No significant news or catalysts behind them, making them suitable for gap fill strategies.
2. Breakaway Gaps:
   • Large gaps that occur when the price breaks out of a range or consolidation.
   • Typically accompanied by high volume and suggest the start of a new trend.
3. Exhaustion Gaps:
   • Gaps that occur at the end of a trend, indicating the exhaustion of the current trend.
   • These gaps are usually followed by reversals.
4. Runaway Gaps (also known as Measuring Gaps):
   • Gaps that appear mid-trend and show a strong continuation of the trend.
   • These gaps are typically followed by further momentum in the same direction.

Gap Trading Strategies

1. Gap Fill Strategy (Reversal)

The Gap Fill Strategy aims to profit from the tendency of common gaps to be filled. This strategy assumes that most gaps will eventually revert to the previous close, as markets tend to correct overextended prices.

How it Works:

• Identify a common gap (usually small, no significant news catalyst).
• Wait for price rejection signals (such as pin bars, engulfing candles, or doji candles) around the gap area.
• Enter when price begins to revert toward the previous close.

Ideal for:

• Range-bound markets or markets that exhibit normal fluctuations after a gap.

Stop-Loss:

• Place the stop just beyond the gap extreme (above the gap high for short trades, or below the gap low for long trades).

Take-Profit:

• Target the previous day’s close or a key support/resistance level.

2. Gap and Go Strategy (Continuation)

The Gap and Go Strategy is used for gap continuation and works well with breakaway gaps and runaway gaps. It focuses on taking advantage of strong momentum after the gap occurs, with the assumption that the trend will continue in the same direction.

How it Works:

• Identify a gap in the direction of the prevailing trend (gap up in an uptrend or gap down in a downtrend).
• Wait for a small consolidation or pullback within the first 15–30 minutes of the market open.
• Enter when price breaks out of the consolidation, confirming continuation.

Ideal for:

• Momentum trades or when the gap is supported by strong news or earnings reports.

Stop-Loss:

• Place the stop just below the consolidation (for gap up) or above the consolidation (for gap down).

Take-Profit:

• Use measured moves (distance of the gap added to the breakout point) or Fibonacci extensions for target levels.

3. Exhaustion Gap Strategy (Reversal at Trend End)

The Exhaustion Gap Strategy aims to profit from exhaustion gaps that occur at the end of a trend. This strategy focuses on trend reversals and anticipates a sharp pullback or market reversal after an overextended trend.

How it Works:

• Identify an exhaustion gap, which usually appears at the end of a trend (gap up in a bull market or gap down in a bear market).
• Wait for a reversal candlestick pattern (such as bearish engulfing, shooting star in uptrends, or bullish engulfing, hammer in downtrends).
• Enter when price breaks below the gap low (for long trades) or gap high (for short trades).

Ideal for:

• Contrarian traders looking for reversal signals after a strong trend.

Stop-Loss:

• Place it just beyond the gap extreme or the most recent swing high/low.

Take-Profit:

• Target the gap fill or previous swing points (key support/resistance).

4. Runaway Gap Strategy (Momentum Push)

The Runaway Gap Strategy is for gap continuation setups that appear mid-trend and suggest accelerating momentum. Traders use this strategy to capture strong trends that follow a runaway gap.

How it Works:

• Identify a runaway gap that occurs mid-trend and signals continuation in the current direction.
• Wait for a small consolidation or pullback after the gap.
• Enter when price breaks above (for bullish) or below (for bearish) the consolidation or resistance level.

Ideal for:

• Trend-following traders who want to ride strong momentum after the gap.

Stop-Loss:

• Place it below the gap low for long trades or above the gap high for short trades.

Take-Profit:

• Use Fibonacci extensions or measured moves to project further price targets.

5. Weekend Gap Reversal Strategy

The Weekend Gap Reversal Strategy takes advantage of the gaps that occur over the weekend, particularly in the forex market. These gaps can be caused by weekend news, geopolitical events, or economic data. Since these gaps often reflect overreaction, traders can use this strategy to profit from the reversion to the previous week’s close.

How it Works:

• Identify a weekend gap that is unexplained or based on news overreaction.
• Look for price rejection signals around the gap’s extremes (e.g., pin bars, engulfing candles).
• Enter when price begins to revert toward the previous week’s close.

Ideal for:

• Forex traders or index traders looking to profit from emotional overreactions after weekend market closures.

Stop-Loss:

• Place it just beyond the gap extreme.

Take-Profit:

• Target the previous week’s close or key support/resistance levels.

6. Daily Gap Trading Strategy

The Daily Gap Trading Strategy focuses on gaps that occur at the market open each day. This strategy is applicable for stocks, forex, and commodities, and aims to take advantage of both gap fill or gap continuation in a daily time frame.

How it Works:

• Identify gaps of 0.5%–1% between the previous close and current open.
• Use price action and technical indicators (RSI, MACD) to confirm whether the gap will fill (revert) or continue.
• Enter based on the directional signal: buy on a gap up in an uptrend (gap continuation) or sell on a gap down in a downtrend (gap continuation).

Ideal for:

• Day traders or those who trade with a shorter-term outlook.

Stop-Loss:

• Place it just beyond the gap extreme or recent swing high/low.

Take-Profit:

• Use previous day’s close (gap fill) or Fibonacci levels for continuation.

Conclusion: Master Gap Trading for Consistent Profits

Gap trading strategies provide traders with opportunities to profit from price imbalances that occur due to overnight or market-moving events. Whether you’re fading gaps for reversals or riding momentum in trend continuation, these strategies offer a clear framework for capturing short-term price moves.

To learn how to implement gap trading strategies effectively and optimise your approach, enrol in our Trading Courses at Traders MBA and enhance your understanding of market sentiment and price action.