How to Trade the Gap & Go
11:25, 12 October 2023
Welcome to the final instalment of our 7-part Power Patterns series where we aim to give you the skills to trade powerful price patterns which occur on any timeframe in every market.
Last but by no means least is the Gap & Go pattern. Price gaps epitomise power and the Gap & Go is must for any active trading looking to take advantage in a spike in volatility.
We’ll teach you:
- How to identify the best Gap & Go patterns
- Why the catalyst behind the pattern is crucial
- A simple technique for managing a Gap & Go trade
I. Understanding the Gap & Go:
The Gap and Go pattern revolves around a simple concept: market shocks take time to fully price in.
A price gap occurs when a stock "gaps" higher or lower from its previous closing price when the market opens. The price gap represents a shock and in certain circumstances traders can anticipate a continuation of price movement in the direction of the price gap.
Here are the key components of the Gap & Go trade setup:
Identify the gap: The first step is to identify stocks that exhibit a noticeable price gap between the previous day's closing price and the current day's opening price. This gap can be either bullish (a gap up) or bearish (a gap down).
Breaking structure: The price gap should break above or below a level of resistance (or support). Gaps that break key structural levels are likely to draw in a higher level of participation.
High volume: The price gap should occur on higher-than-average volume. Higher volume indicates increased participation and suggests that a significant number of market participants are actively reacting to the news or event that caused the gap.
Bullish Gap & Go:
Bearish Gap & Go:
II. Know the catalyst behind the gap:
Stock prices can gap higher or lower for a multitude of reasons and some of the reasons make better trading catalysts than others.
As a general rule, you want the gap to form on a piece of stock-specific newsflow that has recalibrated market expectations.
Remember, central to the pattern working is that the shock which caused the gap must take time to price in – hence mechanical events such as dividends and corporate actions are of no use, so too are confirmed bids.
The best catalysts for Gap & Go trades will be earnings surprises (good or bad), and a change in outlook (good or bad). In general, trading updates tend to lead to more surprises that Interim and Annual Reports, as they occur within reporting periods.
Good catalysts:
- Trading update
- Interim results (change of outlook)
- Annual results (change of outlook)
- Bid rumour
- Broker upgrade / downgrade
Bad catalysts:
- Ex dividend
- Corporate actions
- Global news event
- Confirmed bid
Top Tip: For the stocks you like to trade, make sure you add a calendar alert for when the company releases Trading Updates and Interim/Annual Reports. This may help you to anticipate price gaps.
III. How to Trade the Gap & Go:
Whilst the Gap & Go pattern can be traded in many different ways and on many different timeframes. We favour getting to grips with this pattern on the hourly candle chart first. On this timeframe gaps will be clear, levels of risk can be kept relatively small, and trades can play out across one or two trading days.
Here’s how to start trading the Gap & Go on the hourly candle chart:
Entry: Wait for prices to stabilise following the opening rotations. The gap should be maintained after the first hour of trading and there should be no signs of exhaustion. Enter during the second hour of trading.
Stop-loss placement: Traders can either place a stop above (or below) the 9 period exponential moving average (EMA) or use a multiple of the Average True Range (ATR) above (or below) the entry price.
Price targets: The expectation for the Gap & Go trade setup is to catch a clean swing of price movement in the direction of the gap. For this reason, the 9EMA is a useful tool as a dynamic profit target – traders should close their position on a close back above (or below) the 9EMA. This method does not cap upside in fast moving markets but ensure discipline and allows traders to attempt to capture the ‘meat of the move’.
Bullish Gap & Go Trade Setup:
Bearish Gap & Go Trade Setup:
IV. Managing risks and pitfalls:
Be wary of opening reversals: It is important that prices stabilise and maintain the gap before entering a Gap & Go trade. On occasions, prices will gap lower only to reverse sharply during the first hour of trading. The stronger your understanding of the subtle nuances of trading around the open, the better you will be at trading the Gap & Go pattern.
Risk management: The Gap & Go pattern by definition is trading during an expansion in volatility. Therefore, it is essential that traders implement proper risk management techniques, such as position sizing and diversifying your trading portfolio.
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