Gapping

Definition

Gapping is a term used in financial markets to describe the occurrence of a significant price discrepancy between the close of one trading period and the open of the next, often due to unexpected news or events. This price jump creates a gap on the chart, where no trading activity has taken place. Gaps typically occur in volatile markets and can result in substantial gains or losses for investors and traders.

Phonetic

The phonetic transcription of the keyword “Gapping” in the International Phonetic Alphabet (IPA) is: /ˈɡæpɪŋ/

Key Takeaways

1. Gapping is a linguistic term used to describe a type of ellipsis in which a shared predicate is omitted from two or more coordinated clauses.
2. It often occurs in English when two independent clauses are conjoined with a coordinating conjunction like ‘and’ or ‘or’ , making the sentence more concise and less repetitive.
3. In gapping, the omitted predicate must be recoverable and identical in meaning to the one in the first clause, ensuring that the intended meaning is still clear to the reader or listener.

Importance

Gapping is an important term in business and finance as it refers to a scenario when a financial instrument or security experiences a significant price change with no trading activity in between. This usually occurs overnight or during weekends when market fluctuations cause investors to change their opinions, leading to a sudden price movement. Understanding gapping is crucial for investors and traders, as it helps them prepare for potential risks, market volatility, and manage their investment decisions. It highlights the importance of monitoring global news, corporate announcements and various economic indicators that can influence investor sentiment and lead to sudden gaps in the prices of financial instruments. Additionally, gapping also plays a role in the execution of stop-loss orders, which may fail to protect the intended positions if price moves beyond the specified threshold without trading through it, leading to higher losses than anticipated.

Explanation

Gapping refers to a trading tactic that aims to capitalize on the difference (or “gap”) between the closing price of a financial security on one trading day and its opening price on the next trading day. It occurs when a stock, commodity, or other tradable asset opens significantly above or below the previous day’s close. This discrepancy is often the result of external factors, such as significant company news, market shifts or economic events, which can impact investors’ perception of an asset’s value and result in abrupt price fluctuations.

The purpose of gapping is to profit from these price variations, often taking advantage of the lag in information dissemination between market participants. For instance, skilled investors may purchase assets before the gap up event or sell before the gap down event by identifying factors that may trigger such movements in advance. On the other hand, day traders tend to employ strategies that involve “fading the gap” – trading against the gap direction with an assumption that the market will revert to its original position. Although gapping can provide lucrative opportunities for investors who are able to accurately predict market movements, it is essential to approach this phenomenon with due diligence, as the erratic price shifts may also entail significant risks.

Examples

Gapping refers to a situation in financial markets where a security or a financial instrument opens at a significantly higher or lower price than its previous closing price, creating a “gap” in the price chart. This usually occurs when there is overnight news or events that impact the market sentiment. Here are three real-world examples of gapping in business and finance:

1. Earnings Reports: When a publicly traded company releases its quarterly earnings report, investors and analysts closely scrutinize the data. If the report shows significantly better or worse performance than expected, the company’s stock price may gap up or down when the market opens on the next trading day. For example, if a tech company announces better-than-expected earnings and strong future guidance, its stock price might gap up at the opening.

2. Economic Events: When major economic events or announcements occur, financial markets can be significantly impacted. For example, in June 2016, the United Kingdom held a referendum to vote on whether to leave or stay in the European Union (Brexit). The results, in favor of leaving the EU, were unexpected by many, leading to a substantial gap down in the British Pound (GBP) against other major currencies in the foreign exchange market.

3. Mergers and Acquisitions: Mergers and acquisitions (M&A) can also cause gapping in the stock prices of the involved companies. For example, when a larger company announces its intention to acquire a smaller company, the stock price of the smaller company often gaps up, as investors anticipate that the acquisition will result in a higher valuation for the target company. On the other hand, the acquiring company’s stock price might experience a gap down due to potential concerns about the cost of the acquisition or uncertainty about the merger’s success.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Market gap: The difference between the closing price of a particular asset and its opening price the following day.
• Partial gap: A market gap where the opening price is above the previous day’s close for a long (buy) position or below the close for a short (sell) position but not surpassing the highest or lowest price of the previous day.
• Full gap: A market gap where the opening price is higher or lower than the previous day’s high or low, respectively.
• Gap risk: The potential for losses related to experiencing a market gap, particularly in illiquid markets, which can result in orders being executed at unfavorable prices.
• Gap filling: The price movement that occurs when the market eventually moves to fill an existing gap, or when the asset price oscillates back to the level of the previous day’s range.

Sources for More Information

• Investopedia
• MyTradingSkills
• StockCharts
• IRMI