Gaps are among the most powerful price action signals in trading. When a stock opens significantly higher or lower than the previous close, it creates an opportunity that skilled traders can exploit. Understanding overnight gap plays can add a valuable strategy to your trading toolkit.
What Is an Overnight Gap?
An overnight gap occurs when a stock opens at a different price than where it closed the previous day. The price literally "gaps" over a range, creating a void on the chart where no trading occurred.
Key Concept: Gaps represent a sudden shift in supply and demand, often driven by news, earnings, or market-wide events that occurred while markets were closed.
Types of Gaps
Common Gaps
Regular gaps that occur without significant news or volume. These gaps often fill quickly as they represent normal market noise rather than genuine price discovery.
Breakaway Gaps
Gaps that occur at the start of a new trend, breaking out of a consolidation pattern or trading range. These gaps signal the beginning of significant price movement.
Continuation (Runaway) Gaps
Gaps that occur in the middle of an established trend. They represent a surge in momentum and often occur around the midpoint of a major move.
Exhaustion Gaps
Gaps that occur near the end of a trend. They represent final buying or selling climax and often precede reversals.
Gap Trading Strategies
Gap and Go Strategy
This strategy trades in the direction of the gap, betting that momentum will continue.
- Setup: Stock gaps up on high volume with catalyst
- Entry: Buy when price breaks above opening range high
- Stop: Below opening range low or gap low
- Target: Extension levels or prior resistance
Gap Fill Strategy
This strategy bets that gaps will fill, fading the initial move.
- Setup: Stock gaps without strong catalyst, low relative volume
- Entry: Short gap ups or buy gap downs after initial momentum fades
- Stop: New high (for shorts) or new low (for longs)
- Target: Previous day close (gap fill level)
Gap and Go Example
XYZ reports strong earnings and gaps up 15% from $50 to $57.50.
Opening range first 15 minutes: $56 - $58
Entry: Buy at $58.10 when price breaks above range high
Stop: $55.90 (below opening range low)
Target: $62 (next resistance level)
Risk: $2.20 | Reward: $3.90 | R:R = 1.77:1
Evaluating Gap Quality
Strong Gaps (Gap and Go Candidates)
- Clear catalyst (earnings beat, FDA approval, upgrade)
- Volume 2x or higher than average
- Gap through resistance levels
- Sector strength supporting the move
- Pre-market action confirms direction
Weak Gaps (Gap Fill Candidates)
- No clear catalyst
- Below-average volume
- Gap into resistance
- Broad market is opposite direction
- Extended after recent run-up
Pre-Market Analysis
Preparation before the market opens is essential for gap trading.
Key Pre-Market Tasks
- Scan for stocks gapping 3% or more
- Identify the catalyst for each gap
- Check pre-market volume relative to average
- Note key support and resistance levels
- Determine whether to trade with or against the gap
Risk Management for Gap Trades
Position Sizing
Gap plays can be volatile. Consider using smaller position sizes than usual, especially for gap and go trades where stops may be wide.
Opening Range Stops
Using the opening range (first 5-15 minutes) provides logical stop levels. If price breaks back into the range opposite your trade, the setup has failed.
Time Stops
Many gap setups work best in the first 1-2 hours. If your gap trade has not worked by midday, consider exiting.
Important: Gap trades require quick decisions. Have your plan ready before the market opens, including entry, stop, and target levels.
Gap Statistics
Historical data provides useful context:
- Most common gaps (small gaps without catalyst) fill within the same day about 70% of the time
- Breakaway gaps on strong volume have lower fill rates, often less than 30%
- Monday gaps tend to be larger due to weekend news accumulation
- Gaps after earnings have the lowest fill rates
Common Mistakes in Gap Trading
- Chasing gaps: Entering too late after the opening move has already occurred
- Ignoring volume: Low-volume gaps behave differently than high-volume gaps
- Fighting strong trends: Trying to fade gaps in the direction of the larger trend
- No catalyst research: Not understanding why the stock gapped
- Overtrading: Taking every gap rather than being selective
Track Your Gap Trades
Pro Trader Dashboard helps you analyze your gap trading performance. See which gap types work best for your strategy.
Summary
Overnight gap plays offer excellent trading opportunities when approached systematically. Identify gap type (common, breakaway, continuation, or exhaustion) to determine whether to trade with the gap or against it. Use pre-market analysis to evaluate gap quality based on catalyst, volume, and technical context. Implement proper risk management with opening range stops and appropriate position sizing. Remember that gap trading requires quick decisions and disciplined execution.
Learn more: Pre-Market and After-Hours Trading and Overnight Position Risk.