Gaps can act as important areas of support and resistance. For instance, when an upside gap is formed and price heads higher over the next few days, any subsequent declines later on can be met with support at the lower end of the gap. If this gap gets eventually filled and selling continues, then and only then can the weakness be expected to continue. Similarly, when a downside gap is formed and price heads lower over the next few days, any subsequent rallies later on can be met with resistance at the upper end of the gap. If this gap gets eventually filled and buying continues, then and only then can the strength be expected to continue. An important thing to keep in mind is that gaps are visible only on bar and candle charts. They are not visible on line or point and figure charts.

Types of gaps

There are three types of gaps that we will be discussing in this chapter. These are:

• Breakaway gap
• Runaway gap
• Exhaustion gap

In addition, we will also be discussing about a special type of pattern called an ‘island reversal’, which comprises of two gaps mentioned above: the exhaustion gap and the breakaway gap

Breakaway gap

A breakaway gap, as the name suggests, is a gap that occurs when price breaks out of a price pattern, either on the upside or on the downside. We have already discussed about various price patterns in the previous chapter. When any of these patterns break with a gap, a breakaway gap is said to have occurred. Besides, breakaway gaps can also appear when price breaks out of a support or resistance, trendline, channels etc. A breakaway gap that is accompanied by an increase in volume is a significant development and increases the probability of price continuing in the direction of the breakout. Also, breakaway gaps that occur along with high volume increase the odds that the gap will not be filled any time soon.

Runaway gap

Runaway gaps are those gaps that appear when the price is strongly trending in one direction, up or down. These gaps usually appear somewhere around the middle of the ongoing trend. They are also known as continuation gaps, because they continue the prevailing trend. As runaway gaps are continuation gaps, they must be accompanied by an increase in volume. This is because for the prevailing trend to continue, increased interest by market participants is of paramount importance. Without this increased interest, the gap is likely to quickly filled. There can be more than one runaway gap during the current move. However, with the appearance of each new runaway gap following the first gap, the probability of the trend continuing decreases as it usually signals at an overextended market. Like breakaway gaps, runaway gaps are also not filled any time soon.

Exhaustion gap

Exhaustion gaps are those gaps that appear near the end of a trend, up or down. They represent an overextended market and are usually followed by a reversal in trend. When these gaps appear, it is difficult to say whether they are runaway gaps or exhaustion gaps. Such a distinction can be made only a few days after the emergence of the gap. For instance, if after the emergence of a gap in an uptrend, price continues to exhibit strength in the following days, the gap is likely to be of the runaway variety. However, if the rally starts to fade and price inches lower in the following days, then the gap is likely to be of the exhaustion variety. Exhaustion gaps are usually accompanied by a sharp pick up in volume, sort of like a buying climax or a selling climax (these concepts will be discussed in a later chapter). Unlike breakaway and runaway gaps, exhaustion gaps are quickly filled.