Gap Up Stocks Strategies for Beginners
Have you ever heard of “gaps” in stock trading? If not, don’t worry. I’m here to answer your questions about stock gapping, and I’ll share some strategies I use personally to make the most of stocks gapping up.
I'll also explain why chart patterns are important. But there’s nothing more important than thinking about what drives, or motivates, investors to act. We’re all human players directing the ebb and flow of the market. Psychology, and the role it plays in gapping up stocks, is so crucial to understand.
What Is a Stock Gap?
So, what is a gapper in stocks? Well, all stocks, or other assets, have price patterns. They’re moving in certain directions – be it up or down.
Stock gaps are breaks in those chart patterns. A stock’s price rises – or falls – but there’s very little or no trading in between.
In other words, consider gaps as breaks in a chain.
Why Stock Gapping Occurs
The market is a volatile place. We should always brace for the unexpected – including stock gaps.
Why are stock gaps surprising? It’s because it normally occurs due to an unexpected shift in how investors perceive a stock’s value. This is, of course, hard to predict. It often occurs due to a breaking news story, new financial information, or another significant event.
There are various ways stocks can gap. We’re concerned with gap up stocks.
Stocks gap up when a company’s stock price opens higher than it closed the previous day. So, there’s a gap in the stock price and it’s trending upwards.
What Is Gap Fill in Trading?
Gaps are “filled” when a price returns to its normal pre-gap range. Again, there are many reasons for this, but it often happens when traders “settle” after a flurry of activity around the gap.
Now we’ve covered some basic gap up stock terminology, let’s dig a little deeper into this.
Stocks Gapping Up Pre-market
It’s common for stocks to gap up in the premarket. But what does this mean? Put simply, it’s just when there’s a stock gap during premarket trading. This is the period before trading formally starts for the day.
I watch the premarket closely. If you know what to look for, it can set the tone for the positions you should take during the regular trading day. And if you become a Humbled Trader, you’ll learn exactly what to look for – and more!
Penny Stock Gappers
Let’s take it easy and start with penny stocks.
Say we have a small cap penny stock gapper. It’s actually a reverse split penny stock. What’s this? Well, it’s a reverse split, created by an unscrupulous company artificially driving up prices overnight.
In our example, they release PR about a Chinese licensing deal (that sounds official, doesn’t it?). By the next day’s premarket, the stock gapped up 80%. Does this sound like a stock you might buy for a breakout high? Potentially, but I’d advise against it.
See, these penny stock gap ups are great short sell offs. And it’s all thanks to the sideliners – the bagholders.
What Are Bagholders?
Bagholders are buyers in pain. They’re stuck holding the stock – the bag – after buying prior to a certain point. And they want out. A stock gapping up 80% could be the get-out they’re looking for.
Here’s what could happen. Say numerous traders fell for the PR hype. They want to buy low and sell high, so they drive prices up. Those bagholders can now breathe a sigh of relief – they can get out with a breakeven or small loss.
Chances are, they had stop orders automated and ready to go for a moment just like this.
And what about dip buyers? Consider them the new bagholders!
See, the lesson here is that this gap up stock wouldn’t hold. It had no chance of holding in fact. Too many bagholders wanted out, and the news was all bluster.
Remember, we’re all out there trading together in the market. We’re all market participants – not just candlestick patterns. Just like you don’t want to be the trader left holding the bag, think about the investors out there on the sidelines, holding those bags, looking for a way out. Don’t underestimate the importance of human behavior, or psychology, in how the market unfolds.
How to Make Your Trading Plan
We know how to find gap up stocks, but how do you draw up a technical plan for making moves?
Our stock remarket was hanging around a pair of numbers. I would draw a line at premarket high and then premarket low.
We’ll then factor in the risk if I was shorting. The risk would be the break and hold of the premarket high. I don’t mean to just cover everything if the stock spikes to that.
Many times, these penny stocks will spike to break the highs with buyers chasing, leading to FOMO. However, they don’t hold. The ideal entry would be to scale in short starter at premarket high and add to full size once the premarket low confirms and breaks. I personally prefer 10 min charts because it adds to my confirmation.
If we look at the gap up short set up, it offers us a really good risk reward, because you are risking 50 cents to potentially make $2 filling the gap. That's a good risk reward. Of course, you shouldn’t hold this short all the way down expecting it to hit a much lower number. You want to be covered in pieces along the way.
Another Gap Up Stock Example
In this example, a lot of these people were stuck in the high $40’s. You bet these people are looking for any bounce to get out of this stock. The stock ran from $8 to $70 only a month ago. Then it had a ten-point gap up.
The market hadn’t even opened yet the stock was already selling off its gap.
Those are the penny stock gap up short set ups, but there are circumstances where these penny stock gap ups will not sell off. There are certain criteria and catalysts I look for when these gap ups hold and are great long setups, but that’s for another article.
Large and Mid-Cap Gappers
These are very different from small cap penny stock gap ups.
For large cap stock gap ups, look at what’s driving the stock gapping up. It’s often a great quarterly earnings report, new products or services, or positive news.
These are real positive catalysts that will affect the company’s near- term earning projections. If large cap stock gaps up with this news, I look to long the gap up. For the gap up longs on these mid cap large cap companies, I keep it very simple.
Let’s make up an example. The premarket high was $128. When it breaks, I go long for two points. When it has good news or earnings, the stock would hike rapidly out of the gate.
Again, think about the candlestick charts as the people playing the stock. These stock charts are not just candlestick patterns, they are people in the market. Remember the humans behind the tech analysis!
On our stock the investors, with fresh money want to get in on this company. Since some good news was released yesterday, the opening the next day is the first chance these investors get to enter. The stock is most likely going to hike up really quick.
Now, if you’re not fast enough to get in and out quickly at the premarket high break at the open which is usually the first 10 minutes, the other option for a long is during the consolidation. Again, if the stock has good fundamental news, it most likely will not sell off the gap up.
You can look to enter after the initial sell off at the open. In this case, our stock sold off from $130 to $126. I use the 10 min chart because it keeps me patient and confirms the consolidation for me. Then, you can ride it up from $127 to $130.
I love these large gap ups with solid fundamental news because when these stocks gap up and hold, they offer some great follow throughs the next few days as a swing position.
It's the same set up intraday for another example. I played this along with our first stock using the exact same gap up long set up.
Again, it had impressive quarterly earnings and really good guidance as well as a solid catalyst. Therefore, I long the premarket high break from $109 to $111.
The “Gap Up and Sell Off”
What about mid-cap large-cap stocks that gap up and sell off? Let’s break down a hypothetical scenario.
Stock A trades around $27 dollars. By the close of trading the next day, it rose to $43.
The day after, by premarket, it trades around $50.
Some buyers got in at $27 dollars. Others – the swing traders and dip buyers – got in at $43.
The investors pretty much doubled their investment in 2 days. That's like the fastest growing investment after bitcoin a few years ago. When you have 100% ROI in two days, wouldn’t you want to sell and perhaps reinvest later?
As for the swing traders like me, who got in the day before around $40, you wake up the next morning premarket and see your position up $10. What would you do?
Of course, I would sell. I would take my money and run.
Why? Because think about what’s driving these market moves. Think about every player and what they’re looking to gain. Do they have incentive to buy or to sell?
The answer reveals what you should do.
That’s why the gap up was more of a short than a long. This stock gapped up 10 points overnight NOT because of fundamental solid catalysts like our large stock examples. This stock gapped up because it was a recent IPO and was hyped up.
Remember, we don’t trade in a vacuum. Every trader and investor are linked in some way. Bear this in mind, and you’re already trading more mindfully.
Gap Up Stocks Trading Strategy: Conclusion
Today, I’ve shared gap up stock strategies I use personally – for penny stocks and mid or large-cap stocks. Let me leave you with a summary of what I’ve covered.
If you’re trading penny stock gap ups:
Check the daily chart. Look for potential bag holders and SEC filings.
Do a little research on the companies.
Short the gap fill if you’re happy with what your research reveals.
For those larger stocks:
Did positive overnight news cause the stock to gap up overnight? Long the gap up on the premarket high break. Or if the stock holds the gap, after the good news, then long the gap up.
If there’s no significant catalyst responsible for the gap up, short the stock and gap fill as it heads down.
A Word of Caution About Stock Gapping
Remember, fellow traders, every set up is unique. Not all gappers are created equal – and you can only get so far learning chart patterns.
Think about the mindset or psychology actually driving these stock market decisions. Understanding what underlying motives are at play could help you make better trading decisions.
Hopefully you enjoyed this brief introduction to stock top gappers. For more hints and tips, or to learn the art of day trading success, become a Humbled Trader.
