What it means
Price gaps happen because markets are not open continuously while news is. Earnings released after the closing bell, an overnight regulatory decision or a weekend takeover announcement all get absorbed at the next open, which can be several per cent away from where trading stopped.
Traders care about gaps because they mark a point where sentiment reset without anyone being able to trade through the range. A gap leaves an area on the chart with no volume behind it, which some analysts treat as unstable and likely to be revisited.
The usual working vocabulary splits gaps into a few types. A common gap appears in quiet trading and means little, a breakaway gap starts a new trend out of a range, a runaway gap confirms a trend already in motion, and an exhaustion gap appears near the end of a move just before it reverses.
The phrase "filling the gap" describes price returning to the previous close, closing the empty zone on the chart. Gaps do get filled often enough to be worth watching, but the idea that every gap must fill is a superstition rather than a rule, and gaps driven by a permanent change in fundamentals frequently never do.
Outside charting, the same word does plain duty in planning conversations. A funding gap is the shortfall between cash needed and cash committed, a performance gap is actual results against target, and a gap analysis is simply the structured comparison of where you are with where you intend to be.
In practice
Real-world examples.
Example
A pharmaceutical company announces successful trial results overnight and its shares open 22% above the previous close. Investors who had placed stop-loss orders just below the prior close are executed at the new open, well away from the level they had chosen.
Example
A finance director presents the annual plan and shows a $3.2 million gap between committed funding lines and forecast cash needs for the second half. The board treats closing that gap as the single priority for the quarter and approves an early refinancing.
Example
An operations team runs a gap analysis before a systems migration and finds that four of eleven required data fields are not captured anywhere in the current platform. The finding delays the migration by six weeks but avoids a far more expensive failure after go-live.
Formula
Calculation
Gap size = opening price - previous closing price
Gap percentage = gap size / previous closing price x 100
A listed engineering firm closes on Tuesday at $48.00. It reports better-than-expected results after the close, and on Wednesday the shares open at $52.80.
Gap size = $52.80 - $48.00 = $4.80
Gap percentage = $4.80 / $48.00 x 100 = 10.0%
Later that Wednesday the shares drift back to $50.40 before steadying. The distance travelled back down is $52.80 - $50.40 = $2.40, which is $2.40 / $4.80 = 50% of the gap, so traders would describe the gap as half filled. Only a return to $48.00 would fill it completely, and if the results genuinely reset the earnings outlook, that may never happen.Case study
Seen in the real world.
Brightwater Instruments is an invented, illustrative manufacturer used here to make the idea concrete. Its shares had traded in a narrow band for months when the company disclosed, after the close, that it had lost its largest customer, and the following morning the stock opened at $31.20 against a previous close of $39.00, a gap down of $7.80 or 20%.
Several private investors held stop-loss orders at $37.00 and had assumed that was the worst outcome available to them. Their orders triggered at the open around $31.20, roughly $5.80 a share below the protection they thought they had bought, which is the practical meaning of a gap for anyone relying on stops.
The fictional postscript is instructive. Over the next five months Brightwater replaced most of the lost revenue and the price recovered above $39.00, filling the gap, but investors who had been stopped out at the open had already taken the loss and were not there for it.
Watch out
Common mistakes.
- Assuming every gap eventually fills. Many do, but gaps caused by a permanent change in the business can stay open indefinitely, and trading on the assumption alone is expensive.
- Treating a stop-loss order as a guaranteed exit price. A stop becomes a market order once triggered, so a gap can execute it far below the level you set.
- Reading any gap as a strong signal. Small gaps in thinly traded stocks are often just the spread reopening and carry no information at all.
Questions
People also ask.
What causes most gaps?
Information released while the market is closed, principally earnings, regulatory announcements, deal news and macroeconomic data in other time zones.
Can gaps happen in currency markets that trade around the clock?
Yes, most often over the weekend break or in response to a sudden central bank move, when liquidity thins out and prices jump between levels.
Is a gap analysis the same thing?
No, that is a separate business planning use of the word, comparing current capability with a target so the difference can be costed and closed.
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