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| Breakaway
Gap |
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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