Let me begin with a simple definition of a gap. A gap is the difference between the previous days close and todays open. For example, in order to set a gap chart you would set the close of a S&P emini chart to 4:15pm eastern and the opening to 9:30am eastern. Any action that takes place overnight which shifts the closing price is a gap.
Why do they exist?
Gaps exist due to a variety of reasons. Buyers/sellers may need to unload their inventory aftermarkets causing an imbalance in supply and demand. Significant overnight news can cause market participants to react overnight shifting price. Smaller gaps of less than one S&P point should not be considered significant while larger gaps of 6 S&P points or more should keep you alert. Here is the reason why:
Most gaps fill in the same trading day. Therefore it is crucial to understand whether price is accepted or rejected at these new levels. One way to determine this is to scan premarket volume for SSF's (single-stock futures). A full comprehensive list can be obtained
here. When the SSF's trade significantly above average volume during the premarket, there is a good possibility that the gap will be a professional gap. In other words, the gap will continue in the direction of the gap and will not fill. Another method I use is to determine price has gapped away from yesterdays value and range. If prices do gap above/below
value area and are accepted by the markets during the first 5 minutes of the opening session, I look to go with the gap.
A professional gap is not the norm but the exception compared to the amount of gaps that do end up getting filled. Always ask why the gap occurred and when you can not find 2 good reasons, there is a chance for a gap fill.
