The third and final type of gap is exhaustion gap. From the name one can understand that this gap has something to do with the final stages, for that is when exhaustion sets in. Exhaustion gaps are the gaps which occur at the end of a strong up or downtrend. These gaps are the first signal that the prevalent move (down or up) is approaching to an end.
How can you identify an exhaustion gap? Simple. The gap should be recorded with a large price difference between the previous day’s closing price and the fresh opening price. Furthermore, the volume should be extraordinary. If one does not observe extremely high volume, then it can be safely assumed that the gap is not an exhaustion gap.
Following a long down-trend these gaps materialise due to a bout of panic and pessimism. These gaps symbolize high selling pressure and liquidating of entire holding as investors suddenly lose hope. Equally in an uptrend or bull run, the stock price jumps up with a very high demand for the stock. The exhaustion gaps are filled quickly as the stock price reverses its trend after these gaps. Profit booking happens when exhaustion gap occurs in an up-trend and fresh buying emerges in a down-trend as investors believe that the trend has run its course.
Refer to the Uco Bank chart shown below, in which an exhaustion gap is noticeable. After a long uptrend or bull run from April 2007 low of Rs 20, the stock formed an exhaustion gap at around Rs 71, almost towards the end of the trend. As the gap occurred with very high volume and the stock had rallied strongly prior to this gap, we cannot call it a runaway gap. Therefore it is an exhaustion gap. Subsequently, the stock recorded its life-time high of Rs 88.9 in early January and within a week, the stock reversed its trend due the profit taking and other pessimistic news flow.
Refer to the Alphageo India chart, where all the three types of gaps are depicted. The stock began to trend upward since May 2007. During its upward journey, the stock formed two runaway or measuring gaps, one in late September 2007 and another one during early November 2007.
The stock’s up-trend prolonged further, however, after recording an all-time high of Rs 1,078 the stock reversed its trend. In early January 2008, the stock gapped up accompanied with very high volume, signalling that the up-trend was nearing its end. We name the stock’s January gap as an exhaustion gap. Moreover, Alphageo’s new down-trend was welcomed by forming a breakaway gap.