Gap Definition: Day Trading Terminology
Gaps form on charts when there is a big price movement with no trading in between. This usually happens over night when news comes in and pushes the prices of a stock higher or lower than the previous days close. This is caused by a major difference in supply or demand usually caused by a news catalyst. Gaps can also happen during normal trading hours but is not as common because there is a lot more buyers and sellers than there are overnight.
In the above example, Netflix ($NFLX) had heavy buying pressure following their third quarter earnings release that was better than expected. This created a major imbalance on the buy-side that pushed prices higher overnight with a opening print of $116.63 to start the trading day after closing the previous day at $99.80 equaling a $16.83 gap up.
There are a few things that a stock can do once it experiences a gap. It can hold the higher prices and continue up like in the gap and go strategy we teach, it can stay close to the price it opened at as traders are undecided on which way to take it or it can close the gap and come back down toward where prices closed the previous day. Usually on a big gap up you will see some profit taking at the open, which will bring prices down momentarily, but in this case, NFLX kept raging on strong buying volume.
Gaps can also happen when there is a lot of selling pressure causing prices to open lower from the previous days close indicating sellers are currently in control. This will also be caused by an imbalance in supply and demand usually due to some kind of news catalyst such as earnings.
Warrior Trading Pro Tip
When looking for stocks to trade in the morning you may want to start by looking at stocks that are gapping up or down for two reasons: the stock has a catalyst that has sparked trader interest and because there will be more volume and range for traders to take advantage of.
Active traders need active stocks to make a living and by trading strategies like the gap and go you will be able to take advantage of potentially big movers. These types of trades can be very volatile so its best to practice them in a simulator first to get use the speed before risking real capital.