In technical analysis, even empty spaces have significance. Such spaces between the price movements where no trade has taken place are called gaps. Gaps can be seen in charts all time period, whether hourly, daily, weekly or monthly. They can however be observed only on candlestick or bar charts; they cannot be seen on line or close-only charts.
Gaps imply highly emotional periods. Most often, gaps form between a day’s close and the next day’s opening price. This happens because developments that unfold while the market is closed are absorbed and reflected in the opening price. While gaps are common in daily charts, they are rare in weekly or monthly charts since a gap can be formed on a weekly chart only between Friday’s close and Monday’s opening and between a month’s closing price and the next month’s open on a monthly chart. One can observe frequent gaps in the BSE sensex daily candlestick chart below.
The common classification of gaps is between upward and downward gaps. When the lowest price in a particular trading time period is above the highest level of the previous trading time period is known as upward gap. On the other hand, when the highest price in a particular trading time period is below the lowest price in the previous trading time period is downward gap.
Gaps generally occur in the morning due to overflow of orders. Why do the orders overflow? Reflection of the emotional events that happened after market’s close such as news release, earnings reports, order-win, merger or acquisition result in a deluge of orders at a higher or lower level depending on the impact of the development.
Generally, the gaps get filled or closed because market dislikes vacuum. However, some gaps take quite some time to fill, it could be a day or a week or even a month. Hence, any trading strategies should not be executed on the belief that the gap would be filled or closed in the near feature.
Gaps arise repeatedly in the equities markets; but they are rare in the forex market due to its high liquidity and 24-hour trading. On 8 July, Amrutanjan announced that it had sold its lands and buildings situated in Tamil Nadu, to LIC for a total consideration of Rs 110 crores. This emotional incident, reflected in the form of an upward gap in the subsequent trading session. Refer to the chart above. It took almost one month to fill or close the gap. Gaps occurring while the price pattern is in formation are called as common gaps or area gaps. That are usually closed and do not have technical importance.