Gap Trading

The blank space on the chart

A gap is a price range where no trading occurs — the open of one bar is beyond the high or low of the previous bar, leaving a visible hole on the chart. Not all gaps are equal. Some signal the start of major moves; others fill within hours and mean nothing. The difference is context.

Murphy identifies four types, and the classical framework from Edwards & Magee aligns almost perfectly. Understanding which type you're looking at is the entire game.

The four gap types

1. Common (area) gap

Common gaps occur within trading ranges or congestion areas and are not particularly significant. — paraphrased from Murphy, Technical Analysis of the Financial Markets

These are the noise. They appear inside consolidation zones — rectangles, triangles, pennants — and usually fill quickly. Volume is unremarkable. No one is surprised. The Edwards & Magee tradition calls them "area gaps" because they occur within a price area, not during a directional move.

How to treat them: Ignore them, or fade them. A gap inside a range that fills within a few bars is not a signal — it's a liquidity blip.

2. Breakaway gap

Murphy:

The breakaway gap usually occurs at the completion of an important price pattern, and usually signals the beginning of a significant market move. — Murphy, Technical Analysis of the Financial Markets

This is the gap that matters most. After weeks or months in a base, price gaps through the boundary of the pattern — a neckline, a trendline, a horizontal resistance — on heavy volume. The volume surge is the distinguishing feature. A breakaway gap on light volume is suspect.

Breakaway gaps often do not fill for a long time. If you wait for a pullback to fill the gap before entering, you may never get in. Edwards & Magee noted that a genuine breakaway gap tends to act as support (or resistance, if downward) — the gap itself becomes a zone the market defends.

3. Runaway (measuring/continuation) gap

After the move has been under way for a while, somewhere around the middle of the move, prices will leap forward to form a second type of gap called the runaway gap. — Murphy, Technical Analysis of the Financial Markets

This gap appears in the middle of a trend — not at the start (that's breakaway) and not at the end (that's exhaustion). Volume is moderate to high but the key feature is the speed: the trend is already established, and the gap accelerates it. Runaway gaps often appear about halfway through the total move, which is why they're also called measuring gaps — you can estimate the target by doubling the distance traveled so far.

4. Exhaustion gap

The final type of gap appears near the end of a market move. After all objectives have been achieved, the analyst should begin to expect the exhaustion gap. — Murphy, Technical Analysis of the Financial Markets

The trap. Price gaps in the direction of the trend, panic buying (or selling) peaks, and then the move stalls. If the exhaustion gap is followed by a reversal that closes back below (or above) it, you've confirmed the island reversal — one of the strongest short-term reversal patterns in classical TA.

The exhaustion gap fills quickly and decisively. That's how you distinguish it from a runaway gap: runaway gaps hold; exhaustion gaps don't.

Gap fill rates: what the statistics say

Common gaps fill most of the time (often within 1–5 trading days). Breakaway gaps on heavy volume have the lowest fill rates — many never fill during the subsequent trend. Exhaust gaps fill quickly by definition, since the reversal pushes price back through the gap.

Bulkowski's Encyclopedia of Chart Patterns provides the most granular data. His methodology counts whether the gap gets filled within a specified number of bars — and his numbers consistently show that gaps at pattern breakouts (breakaway) outperform gaps mid-pattern (common) by a wide margin in terms of the subsequent move size.

The practical takeaway: gap type determines your reaction time. Common gaps give you days to act (or not). Breakaway gaps demand a decision now — waiting for a fill means missing the move entirely.

Reading a gap in real time

You can't label a gap until you have context. Here's the decision tree:

1. Where is the gap relative to a pattern or trend?

   • Inside a range → common
   • Breaking out of a range → breakaway
   • Mid-trend, continuing direction → runaway
   • Late in a trend, after extended move → exhaustion

2. What's the volume?

   • Heavy on a breakout → breakaway (strong)
   • Heavy at the end of a trend → exhaustion (danger)
   • Light anywhere → common or suspect breakaway

3. Does it fill?

   • Quick fill → common or exhaustion
   • Holds for days/weeks → breakaway or runaway

The island reversal

When an exhaustion gap up is followed (within days) by a breakaway gap down — isolating a small cluster of bars between two gaps — you get an island reversal. The isolated bars look like an island surrounded by gap-water on both sides. This is a high-conviction reversal signal because it means the last buyers are now trapped above two gaps they can't cross without panic selling.

Edwards & Magee considered the island reversal one of their most reliable short-term reversal formations, though they noted it's relatively rare. Modern chart software makes them easy to spot — look for two gaps in opposite directions within 1–5 bars of each other.

Quick check

What you now know

• Four gap types: common (noise), breakaway (trend start), runaway (trend midpoint), exhaustion (trend end).
• Volume is the key distinguisher — heavy volume at a pattern breakout = breakaway; heavy volume after an extended move = exhaustion.
• Breakaway gaps hold; exhaustion gaps fill quickly. That's the real-time tell.
• Runaway gaps are measuring tools — they mark roughly the halfway point of a move.
• Island reversals (exhaustion gap + reversal gap) are rare but high-conviction reversal signals.

Next: Elliott Wave Basics — the 5+3 wave structure, the three inviolable rules, and the Fibonacci connection that underlies the entire framework.