Now continuing with the Short term patterns we will be discussing types of Gaps patterns i.e Runaway Gap and Exhaustion Gap:
Runaway Gaps
Runaway gaps are also called measuring gaps, which are caused by increased interest in the stock. For runaway gaps to the upside, it usually represents traders who did not get in during the initial move of the uptrend and while waiting for a retracement in price, they decided it was not going to happen.
There is increased buying interest all of a sudden and the price gaps above the previous day's close. This type of runaway gap represents an almost panic state among traders and a good uptrend can have runaway gaps caused by significant news events that cause new interest in the stock. There is a significant increase in volume during and after the runaway gap.
Exhaustion Gaps
Exhaustion gaps are those that happen near the end of a good up or downtrend. They are at times the first signal of the end of that move and are identified by high volume with a large price difference between the previous day's close and the new opening price. It is almost a state of panic if the gap appears during a long down move where pessimism has set in as selling all positions to liquidate holdings in the market is not uncommon. Exhaustion gaps are quickly filled as prices reverse their trend.
In a similar way, if the gap happens during a bull move some bullish euphoria overcomes trades and buyers cannot get enough of that stock. The prices gap up with a huge volume and then there is a great profit taking and the demand for the stock totally dries up. Prices drop and there is a significant change in the trend.
The author is Associate Vice President - Analyst-Derivatives at Motilal Oswal Financial Services Limited.
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