How to trade using Breakaway (or Breakout) Gap Trading Strategy?

Today we are going to learn about Breakaway (or Breakout) Gap Trading Strategy

A gap occurs when price skip between two trading periods, skipping over certain prices. A gap creates a void on a price chart. Price gaps are simply areas on the chart where no trading has taken place.

Why do prices gap up or gap down?

• Gaps are the Greatest imbalance between demand and supply. Price gap ups because of aggressiveness by buyers, I mean there are more buy orders at the open than there is available supply at the prior day’s closing price. Price gap downs because of the aggressiveness of the sellers, I mean there are more sell orders at the open than willing demand at the prior day’s close. Therefore, gaps are almost always at price levels where there is a supply and demand imbalance at the open.

• Gaps also occur due to the overnight sentiment of the participant or any big news

• Gaps are created when Smart money tries to skip important support and resistance level, i.e. If they are bullish they gap-up price above the supply zone

The Gap fill

The gap-fill refers to the price retracement after the gap to close the level where the origin of the gap occurs. Once gaps are filled by price retracement, the gap tends to reverse direction and continue its way in the direction of the gap (Example: if price gaps up, it may retrace after a while to fill the gap and once gap is filled, price will bounce back and continue it’s uptrend)

Different parts of Breakaway (or Breakout) Gap Trading Strategy

The breakaway gap means breaking the important support or resistance or significant trend line in the form of the gap. This generally appears after if there is significant price build up or price consolidation near the support or resistance zone on the previous day.

There are three major parts which forms this pattern.

1.      Consolidation – The market consolidates on the previous day, forming tight candles throughout the last hour of the previous day. This consolidation happens near a major support or resistance area.

2.      Gap up & Rally – Price gaps up the next day above the consolidation zone or above the resistance area and continue to rally from there. This event had flipped our resistance zone into support zone, so we can call it flip zone.

3.      Pullback – After a brief rally, price starts dropping towards the flip zone (previous resistance, which has turned into support now)

Things to Remember/Why the breakaway gap occur?

The smart money knows exactly where these resistance areas are. If the smart money is bullish, and higher prices are anticipated, the smart money will certainly want a rally. The problem now is how to avoid the old resistance

• Gapping up through an old area of supply as quickly as possible is an old and trusted method – a way of avoiding the resistance.

We now have a clear sign of strength. Smart money does not want to have to buy the stock at high prices. They are already bought their main holding at lower levels.

Smart money knows that a breakout above an old trading resistance area will create a new wave of buying. How?

• Many traders who have shorted the market will now be forced to cover their poor positions by buying as well.

• Many traders are looking for breakouts will buy.

• All those traders who are not in the market may feel they are missing out and will be encouraged to start buying.

Here you can see that prices have been quickly up moved by smart money, whose opinion of the market at that moment is bullish. We know this because the volume has increased. It cannot be a trap up move, because the high volume is supporting the move

Importance of volume:

As I always say, the volume is most important thing you need to check for in any technical breakout pattern. This is applicable for gaps as well. It will be considered as double confirmation when the price gaps up and continue to move up with big volume.

Entry, Target and SL

You can enter into the trade once the price pullback to the flipzone

The target for this strategy is simple – use the previous high made as Target 1 & 2X of it as target 2.

When it comes to SL, Once the price gaps up above the flipzone, the flipzone point becomes your immediate support and you can keep low of the flipzone as your SL.

For more details and examples, checkout the video: