Gaps as potential Support and resistance
Different types of gaps in chart analysis
- Breakway gaps
- Exhaustion gaps
- Common gaps
- Continuation gaps
How gaps are normally formed
Understanding Gap Formation in Range-Bound Stocks
Oftentimes, a stock will trade in a relatively narrow price band between support on the lower end and resistance on the upper end. This is known as a price range or consolidation area. The support level is where buyers tend to enter, preventing the price from dropping lower. The resistance level is where sellers push back, stopping upward progress.
Breaking Out of the Range
For a stock to break out of this range, it needs significant buying or selling pressure behind it—typically reflecting a shift in market sentiment or outlook. Heavy trading volume comes in to either lift the price above resistance or sink it below support. Sometimes this high-volume thrust happens right at the market open, creating an visible open gap between the prior close and next open.
Other times, the move may happen mid-day but with enough momentum to gap through short-term support or resistance levels on its way higher or lower. These breakout gaps signify traders and investors decisively shifting their viewpoints on the stock’s valuation.
New Price Levels Emerge
After the range breaks and a stock gaps in one direction or the other, former support and resistance levels lose relevance. The price where the stock initially broke out now serves as a new support (if breakout was upwards) or resistance (if breakout was downwards). Any pullbacks towards this breakout level may attract buyer interest for a support level. Meanwhile, rallies towards it could elicit seller interest at this new resistance.
Analyzing volume trends, market events, and sentiment shifts around gap days allows traders to gauge conviction behind new trends. Identifying and properly interpreting gaps in key price areas remain an invaluable skill.
Gaps acting as support or resistance
Gaps will act as
effective support and resistance zones. I said zones as we always consider
support and resistance as price areas or zones and not a fixed point.
Those who missed the
chance to buy in the gap zone will try to buy when price reaches there. They
get a second chance to buy. When market reaches the level they will buy and
move price up. We know support zones are also called demand zones where buying
halts down movement of price and price starts to reverse from there.
Same thing happens in case of resistance. The difference is sellers will be waiting to sell there and thus price falls once reach that levels.
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