What Is Absolute Price Gap?
An Absolute Price Gap refers to the visible empty space on a financial chart, typically a candlestick chart, that occurs when a security's price opens significantly higher or lower than its previous closing price with no trading activity in between. This phenomenon is a key concept within technical analysis, a methodology used by traders and investors to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and trading volume. Such gaps indicate a rapid shift in market sentiment or the impact of significant news outside of regular trading hours.7, 8
History and Origin
The concept of price gaps and their interpretation has been an integral part of technical analysis for many decades, evolving alongside the study of chart patterns. Early pioneers in technical analysis, who observed price movements on hand-drawn charts, would have naturally noticed these abrupt discontinuities. The formalization of gap analysis as a trading strategy gained prominence with various researchers and traders. For instance, in the early 1980s, noted commodity trader and researcher Larry Williams developed a strategy named "OOPs" which focused on the tendency of commodities that gapped lower to reverse and move higher, highlighting a statistical edge.6 Later, in 1990, Toby Crabel's work, "Day Trading with Short Term Price Patterns and Opening Range Breakout," further explored price patterns, including gaps, solidifying their importance in short-term trading strategies.5
Key Takeaways
- An Absolute Price Gap represents an area on a chart where no trading occurred between two consecutive trading periods.
- Gaps typically form due to strong market-moving news, unexpected announcements, or shifts in supply and demand occurring outside of regular trading hours.
- They are categorized into different types (common, breakaway, measuring/runaway, and exhaustion gaps), each with varying implications for future price action.
- While some gaps tend to be "filled" (meaning the price reverts to the pre-gap level), this is not guaranteed and can take significant time.
- Analyzing absolute price gaps can provide insights into market momentum, potential trend reversals, or continuations.
Formula and Calculation
The Absolute Price Gap is calculated as the absolute difference between the closing price of one period and the opening price of the subsequent period.
For an upward gap (Gap Up):
Where:
- (\text{Opening Price}_{\text{Today}}) = The price at which the security opened today.
- (\text{Closing Price}_{\text{Yesterday}}) = The price at which the security closed yesterday.
For a downward gap (Gap Down):
Where:
- (\text{Closing Price}_{\text{Yesterday}}) = The price at which the security closed yesterday.
- (\text{Opening Price}_{\text{Today}}) = The price at which the security opened today.
This calculation quantifies the magnitude of the price jump or drop, distinct from the bid-ask spread234