Index Gaps and How They Fill

Because the share market closes each day and the news does not, the next open often starts at a different level from the previous close. The empty space on the chart is a gap, and gaps on index charts behave in ways that are regular enough to plan around.

Why gaps happen

Overnight, the index futures keep trading and react to Asian and European sessions, to company results released after the close, and to macro news. By the cash open, the futures have moved and the cash index opens where the futures say it should. The gap is the overnight move compressed into one tick.

Fill or run

A gap fills when price returns to the previous close. Whether it does depends mostly on why it happened:

• Small gaps with no clear cause fill most of the time, often within the first hour, because they reflect noise rather than information
• Gaps caused by a single scheduled event, such as a data release, often fill partially as the first reaction fades
• Large gaps on genuine news, especially gaps that break a daily level, tend to run, because the information has changed the valuation of the index

The size of the gap relative to the average daily range is the quickest guide. A gap smaller than a quarter of the daily range is noise; one larger than the whole range is a regime change.

Trading the fill

The fill trade enters against the direction of the gap once the opening range has formed and price has failed to extend. The stop goes beyond the opening range extreme and the target is the previous close. This trade works best on small, newsless gaps and on days when the opening range is narrow.

Trading the run

The run trade enters in the direction of the gap on a break of the opening range, with the stop inside the range. It works best on large gaps with a clear cause and on days when the first fifteen minutes show no attempt to fill. Candle size should expand on the break; a break on small candles is a sign the gap is tired.

A gap that does not fill becomes a level. Price often returns to it days or weeks later, and the edges of the gap act as support or resistance.

What to watch

Watch the size of the gap against the daily range, the cause of the gap, the behaviour of the first fifteen minutes, and candle size on any break of the opening range. The first fifteen minutes usually tell you which trade is available.