Gap Patterns

Gaps are a sign of strong reaction in prices which may be a valid price move or a false move caused by an announcement that turned out to be incorrect. Gaps are caused when there is an excess of buying pressure or selling pressure.

For example, if there is something that creates a greater expectation for higher prices, then the share will start trading at a higher level than yesterday, leaving a gap. If a gap remains open after 3 days then it is a valid price move and prices should keep moving in that direction. If prices return and move back through the gap, then the price move may have been a false move and the probable trend will be in the opposite direction to the gap. The major problem with gaps is that it takes several days to see if they are valid or not.

Gaps can be very useful when used in combination with the overall chart pattern and other technical indicators. Gaps can be formed in up and down markets.

Island Reversal
This is one of the strongest reversal patterns. The island can be one bar or a few days. It represents a dramatic change of sentiment and leaves one side trapped. It's these people exiting their positions that forces prices in the opposite direction.
Chart: The high and low of the island bar must be outside the range of the preceding and following bars. The last day should reverse at least two closes and close below that day's mid range.

Reversal Gap
This is a high probability reversal pattern where an up trend is reversed by a gap.
Chart: The high of the last day is below the previous day's action. The close should be below the last two closes and close below that bar's mid range.

Pattern Gap
This is a lower probability reversal signal where the selling pressure is not as great as the previous patterns.
Chart: The high is below the close of the previous day. The close is below the mid range and should be below the last two closes.

Exhaustion Gap
This is the hardest to pick as it is a continuation gap at the end of a strong trend that is over done and indicates a probable trend reversal. When the prices pass back through in the opposite direction, the trend has reversed.
Chart: Prices have been in a strong up trend and there is a final display of buying pressure that is the last buyers getting in and now there are no more buyers left. Traders start taking profits by selling which starts a down trend.

The Runaway or Breakaway Gap
This is where the prices jump without trading in the direction of the trend and indicates that the trend will continue if it is not filled. They often signal a move out of congestion or an announcement early in the trend.
Chart: Prices move out of a consolidation area with excess buying pressure. Be careful with these gaps as they may be genuine buying pressure or a false break caused by stops being hit.

Continuation Gap
This pattern indicates the continuation of a trend and appears during a strong trend. It is a high probability trading signal as it is usually an indication of continued strong buying.
Chart: Prices are already in an uptrend and the buying pressure increases leaving a gap.