What It Is:
A gap is a "hole" in the chart -- a space or a vacuum that is empty, at least temporarily, of price action. There are four types of gaps: common, breakaway, runaway, and exhaustion. 

In contrast to a "common" gap, which occurs within a price pattern, a "breakaway" gap completes a price pattern such as a rectangle or a triangle.

How It Works:
There are several reasons why a gap might appear in the graph of an individual stock. One of the most common causes of a gap is an earnings release that is above or below Wall Street's expectations. Other causes of gaps include an analyst upgrade or downgrade, a merger announcement, or the release of a significant news item. 

A large gap implies a temporary supply/demand imbalance. The larger the gap, the more extreme the imbalance. A downside price gap of several dollars -- particularly on high volume -- reflects urgent selling. On the other hand, an upside price gap of several dollars on high volume represents intense buying. This sense of urgency is seldom played out in a single trading session.

The historical chart of Eastman Chemical below illustrates both a common and a breakaway gap. The common gap occurred within a symmetrical triangle and was filled reasonably quickly. However, the breakaway gap happened as the symmetrical triangle was resolved to the downside. Note the volume spike as the downside gap occurs -- daily volume was more than four times normal daily levels. On a rally, the top-end of the gap near $52 should now be strong resistance and can be used to set the stop loss level. 

Why It Matters:
Breakaway gaps provide high probability trading opportunities. Although the stock has already moved, it is likely to rise or fall much further. The gap also helps the trader limit potential losses. A stop loss placed above the upper-end of the gap -- $52 in the case of Eastman -- will prevent a large loss should the stock reverse. 

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