Gap Trading: Profiting from Overnight Price Moves

Introduction

Gap trading is the practice of identifying and trading the price differences that appear between a market's close and the next session's open. These overnight or between-session gaps can present fast opportunities, or traps, depending on the reason behind the move. Why do gaps happen, and how should you treat them when you see one in your watchlist?

This article explains the main gap types, the probabilities around gap fills, and practical entry and exit techniques you can use. You will learn how to combine gap analysis with volume, support and resistance, and common indicators so you can make more informed short-term decisions.

• Understand the three primary gap types: breakaway, runaway, and exhaustion, and how they influence trade direction.
• Learn how to assess gap credibility using volume, market context, and price action.
• Follow step-by-step entry and exit techniques for gap fills, continuation trades, and pullback setups.
• See real-world examples with $AAPL, $TSLA, and $NVDA and practical trade sizing and risk rules.
• Avoid common mistakes like trading gaps without context, ignoring volume, and overleveraging.

Types of Price Gaps and What They Mean

Not all gaps are created equal, and knowing the type helps set expectations for whether the price will reverse or continue. The three widely accepted gap types are breakaway, runaway, and exhaustion.

Breakaway Gaps

A breakaway gap appears when price clears a consolidation range or a major support or resistance level on strong news or fundamental change. These gaps usually signal the start of a new trend or leg, and they are less likely to fill quickly.

How to identify one: the gap occurs off a tight base or a trendline break, and volume at the open is significantly higher than recent sessions. For example, if $NVDA gaps up after a bullish earnings surprise and opens above a well-defined resistance with heavy volume, that is likely a breakaway gap.

Runaway Gaps

Runaway gaps happen within an existing trend, often marking a strong continuation after the market accepts the new price level. They show conviction among buyers or sellers and tend to leave a directional bias intact.

Runaway gaps are common when momentum accelerates, as in a strong bull market rally. You might treat a runaway gap as an opportunity to enter in the direction of the trend on a measured pullback or on momentum confirmation.

Exhaustion Gaps

Exhaustion gaps appear near the end of a trend and are often followed by sharp reversals. They can be identified by a dramatic gap with a spike in volume and a quick failure to follow through over the next few sessions.

If $TSLA gaps higher on very high volume but quickly gets sold back below the gap within a day or two, that could be an exhaustion gap. Traders often watch for these to fade as a mean reversion opportunity.

Gap Fill Statistics and What They Imply

How often do gaps fill? There's no single number that fits every market, timeframe, or gap type, but empirical studies and market experience offer useful guidance. Broadly, many gaps will fill eventually, though timing and frequency depend on the gap type and context.

• General estimates. Empirical studies suggest roughly 50 to 75 percent of intraday and overnight gaps fill within days to weeks, but this varies by market regime and volatility.
• By type. Exhaustion gaps have a higher short-term fill rate, often within a few sessions, because they mark reversals. Breakaway gaps have the lowest fill probability in the short term, because they signal new trends.
• Time horizon. Many gaps that will fill do so within 5 to 20 trading days, but some take months, especially if the gap coincides with a lasting change in fundamentals.

These statistics aren't guarantees, but they help set your expectations. You should always couple them with volume and overall market context when sizing and timing trades.

Entry and Exit Techniques for Gap Trades

Trading gaps requires a clear plan with predefined entries, stops, and targets. Here are practical approaches tailored to common scenarios you will encounter.

Trading the Gap Fill

Gap fills are mean reversion trades that assume price will revisit the pre-gap level. Entries are often set when price returns to the gap area, or on signs of rejection when price approaches the gap edge.

1. Identify the gap range, the high and low of the first trade range after the open.
2. Wait for price to move into the gap. Passive entries reduce risk of premature exposure.
3. Confirm with volume and reversal patterns, like a hammer or engulfing candle in the gap area.
4. Place a stop below the recent swing low if you're long, or above the recent swing high if you're short. Size the trade so a stop loss equals a small percent of capital, typically 1 to 2 percent.
5. Set targets near the gap fill level, or use partial exits and a trailing stop once price reaches mid-gap.

Trading Continuation (Breakaway/Runaway)

Continuation trades assume the gap signals trend strength. You want confirmation, because chasing a gap without it increases risk.

1. Look for follow-through price action in the first 1 to 3 sessions, especially new highs in an up gap or new lows in a down gap.
2. Volume should be at or above the gap session's volume for credibility. Low volume gaps are more likely to fail.
3. Enter on a pullback to a logical level, such as prior resistance turned support, a moving average, or a trendline.
4. Place a stop below the pullback low for longs, and scale out as momentum weakens.

Using Limit and Stop Orders

Because gaps happen at the open, limit orders can miss fills and stop orders can trigger at unexpected prices. Many traders use a combination: place limit entries on conservative mean reversion trades and use stop-limit or market orders for breakout follow-through trades with predefined risk controls.

Volume and Indicator Confirmation

Volume is the single most useful confirmation when trading gaps. It tells you whether institutions or retail traders are participating in the move. Combine volume with indicators for higher-probability setups.

Key Volume Rules

• High volume on the gap session supports a directional thesis, especially for breakaway and runaway gaps.
• Spikes in volume followed by quick retracement suggest an exhaustion gap, offering a fade opportunity.
• Gaps on low volume are often unreliable and more likely to fill, so reduce position size or skip the trade.

Useful Indicators

Indicators are tools, not substitutes for price and volume. Use them to refine timing.

• Moving averages, like the 20 or 50 period, help you identify pullback zones for continuation entries.
• Relative Strength Index, RSI, can show overbought or oversold conditions that support a gap fill trade.
• On-balance volume and volume profile help identify whether higher prices are supported by real buying pressure.

Real-World Examples and Trade Walkthroughs

Let's look at realistic scenarios to make the concepts tangible. These are hypothetical trade examples based on common patterns and are not investment advice.

$AAPL Gap Fill Example

Situation: $AAPL closed at 150, then gaps down to open at 144 on an overnight miss in guidance. The gap is 6 points, about 4 percent.

1. Context: The gap occurs after a multi-week uptrend. Volume on the gap day is moderate, not unusually high.
2. Plan: Because this looks like a possible exhaustion or short-term correction gap, you mark the gap range and wait for price to approach the 150 level. You look for a bullish reversal pattern and RSI moving out of oversold.
3. Entry and risk: Enter when price shows a bullish engulfing candle at 146, place a stop at 143, risking about 3 points. Target the gap fill near 150 with a partial exit at 148.

Rationale: The trade assumes a mean reversion to the prior close, with moderate risk due to the prevailing uptrend. If volume spikes on the gap without follow-through, you would treat this as an exhaustion scenario and avoid a continuation bias.

$TSLA Breakaway Gap Continuation Example

Situation: $TSLA has been trading in a tight base around 250. An earnings beat results in an open at 280 on very high volume, breaking long-term resistance.

1. Context: High-volume breakout above a clear base, this looks like a breakaway gap. Short-term fill probability is lower.
2. Plan: Avoid chasing at the open. Wait for a pullback to the new support near 270 or a 20-period moving average test.
3. Entry and risk: Enter on a successful test with volume declining on the pullback and then rising on a subsequent up leg. Place a stop below 265 and trail the stop as price extends.

Rationale: This trade respects the breakout and uses a disciplined pullback entry to improve the risk to reward. If price fails to hold the support and returns into the base, exit quickly to limit losses.

Common Mistakes to Avoid

1. Trading gaps without context, such as ignoring sector strength or earnings, leads to false signals. Always check why the gap happened and the broader market.
2. Relying only on gap-fill statistics, expecting every gap to revert, will get you into trouble. Use volume and price action to confirm.
3. Chasing the open with large size, especially after a strong directional gap, increases slippage and risk. Scale in or wait for confirmation.
4. Ignoring overnight news and after-hours liquidity. A gap driven by structural news can change the calculus for how long a gap will persist.
5. Poor risk management, like oversized positions or no stop, can convert minor losses into account-damaging trades. Size to a small percentage of capital and use stops.

FAQ

Q: What timeframes work best for gap trading?

A: Gap trading is commonly done on daily charts, because gaps are measured between daily closes and opens. You can use intraday charts for execution and timing, especially 5 to 60 minute charts, but align your trade rules to the same session definitions.

Q: Are gaps more common during earnings season?

A: Yes, earnings season increases the frequency and magnitude of gaps because companies release material information outside regular trading hours. Expect more volatility and adapt your position sizing during that period.

Q: How should I size positions when trading gaps?

A: Position size should be tied to your stop distance and total risk per trade. A common approach is to risk 0.5 to 2 percent of your account on any trade. Tighter stops reduce position size, larger stops require smaller position sizes to keep risk constant.

Q: Can algorithmic strategies exploit gap behavior?

A: Yes, some algorithms scan for gap patterns and execute limit or market orders automatically. However, they must account for slippage, after-hours liquidity, and the reason for the gap. Human oversight is often required for news-driven moves.

Bottom Line

Gap trading can offer high-probability setups if you understand the reason behind the move and use volume and price action for confirmation. Different gap types carry distinct probabilities, so classify gaps before you trade them. You should also apply disciplined risk management and avoid trading gaps in isolation.

Next steps: add a gap scanning filter to your watchlist, backtest a small set of rules on historical data for your market, and paper trade the entry and exit techniques described here for a few weeks. At the end of the day, trading gaps is about marrying clear rules with careful execution and adapting to market context.