Do All Gaps Need To Be Filled?

First off, what does it mean for a gap to be filled?

A gap "getting filled" is when price action at a later time retraces to the closing price of the day preceding the gap. Once it's retraced fully, then the gap is considered filled. If a gap only retraces a portion of the way to the closing price of the day preceding the gap, then it's partially filled.

Click on chart to enlarge view.

There are four types of gaps, each with their own characteristics and significance: The common, breakaway, runaway, and exhaustion gap.

A common gap is the most frequent and insignificant gap. It generally occurs during trading ranges or areas of congestion, is accompanied by relatively low trading volume, and is usually filled very quickly. These types of gaps can be caused by anything from a stock going ex-dividend, a trading vehicle re-adjusting to the index it's tracking due to different market/trading times, or a simple short-term supply/demand imbalance.

As we can see in the chart of the S&P 500 from the last few weeks, there have been several common gaps on average volume that were quickly filled and did not impact the overall trend (or lack thereof).

A breakaway gap occurs when prices are breaking out of a range on significant volume, developing a new trend. As a result of a new trend bringing in new market participants and catching many off-sides, this gap generally does not fill and sees upside follow-through relatively quickly. The less that it's filled, the more clear that a strong new trend has developed.

A good example of this is Deere & Co. breaking out of a nearly 6-year base in late 2016, with prices gapping above resistance on high volume, not filling any of the gap, and then quickly seeing upside follow-through.

Another great example is Square in 2017. The stock gapped above resistance on high volume, based for two months, and then continued higher. It's gone on to rally roughly 500% since that breakaway gap.

Breakaway gaps, like the others, can occur on both sides of the tape. Applied Materials saw a downside breakaway gap on high volume in August, consolidated for a week or two, and has been trending lower since.

The next type of gap is a runaway, or measuring gap. These types of gaps typically occur within an already established trend and are caused by an increased interest in the stock. Buyers or sellers become impatient and decide that they need to get long or short the stock now, rather than wait for a pullback to establish/add to a position.

A good example of this is Activision Blizzard, which experienced a breakaway gap in early 2013 and then a runaway gap in July after prices had established a range to digest the gains its initial move. Buyers became impatient, causing a gap to new highs on high volume that ultimately was partially filled, but acted as support and the trend continued higher.

Another good example of an upside runaway gap is IDEXX Laboratories in 2016 and 2017. The stock broke out of a consolidation in May 2016, forming a new trend. It then experienced a runaway gap in August 2016 and February 2017, both of which extended the stock's uptrend.

The last type of gap is an exhaustion gap, which gets its name because of its tendency to occur after an extended trend and indicates a reversal. This type of gap can be identified by a wide gap between the previous day's close and the new opening price, as well as a huge increase in volume. This type of action occurs due to simultaneous euphoria from those on the right side of the trend, and capitulation by those who have been fighting it.

A decent example of this is the exhaustion gap that occurred in the 20+ Year Treasury ETF  in December 2008. Prices saw two gaps higher late within an uptrend as volume spiked, followed by a 2-week consolidation that ultimately resolved in a sharp downward move that filled the gaps and signaled a reversal of trend.

There are some better examples out there with huge volume spikes and massive wide-ranged price bars, but I thought it'd be best to pick a less extreme example and show what a normal exhaustion gap may look like.

As you can see, not all gaps are created equal, and therefore a generalization like "all gaps need to be filled" is not something we should pay mind to. Instead, we ask ourselves the questions:

1. What type of gap is this?
2. How does this gap fit within the context of the rest of our evidence?

While these questions may not make us sound as smart and take actual work, I promise that they're a more productive use of time and energy.

So if you see someone using "all gaps need to be filled" or another version of the phrase, feel free to send them this post or the stockcharts.com article on gaps that I used as a reference. And remember that they may using this broad generalization to rationalize being on the wrong side of the market, so if they react negatively, just know it's not personal.

Thanks for reading and let us know your thoughts!

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Allstarcharts Team