How to mind the gap

Some advice for dealing with the sudden price changes that can hit a stock.

By Kim Peterson Sep 22, 2010 2:57PM
Gaps are always interesting on a stock price chart. For whatever reason, something happens that causes a price to suddenly jump up or down.

Often, that occurs when a company announces good or bad news after the bell. The next day's trading opens with a gap, and some investors strategize around it.

Investopedia has a nice breakdown on how to play the gap, and describes the four gaps that are often seen. Some show up at the end of a price pattern, before a new trend breaks or in a last-gasp attempt to jump higher or lower.

When a gap returns to its original price level -- as many of them do -- you can say the gap has been "filled," according to Investopedia. When this happens on the same day, it's referred to as "fading."

So how do you mind the gap? Investopedia offers some ideas, which I'll summarize here:

  • When positive earnings reports are released after-hours, some investors will buy immediately in hopes of a gap the next trading day.

  • If you're canny enough to sense the beginning of a price trend, you can buy at the first sign of a gap and hope the momentum continues. On the other hand, you can watch a gap ride all the way up and try to short it at the peak.

  • Once a stock starts to fill, it doesn't often stop.

  • Watch trading volume as well. High volume can signal the beginning of a new trend, while low volume might simply mean that the end of the pattern is near.

  • Make sure you have a safety net in place by using a stop-loss.

Investopedia has more here.

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