I sill don’t get it. Why do traders need to go back and fill opening day gaps, even sometimes waiting a year to fill the gap?
AIGemeni tries to explain
It's a common observation in trading that price often returns to "fill" opening day price per share (PPS) gaps, and it can indeed seem mysterious why this happens, sometimes even after a significant amount of time. While there's no absolute guarantee that every gap will be filled, and the reasons aren't always perfectly clear-cut, here are the main psychological and market dynamics that contribute to this phenomenon:
1. Psychological Factors and Market Memory:
Unfinished Business: Gaps represent a period where there was a significant imbalance between buyers and sellers at certain price levels. It can feel like "unfinished business" to the market. Traders who missed the initial move or feel like certain price levels weren't adequately traded through may anticipate a return to those levels. Reference Points: Opening prices, especially after significant news or events, can act as strong psychological reference points for traders. They remember the price where the market opened and may expect it to be revisited. Regret and Opportunity: Traders who were on the wrong side of the gap might look for an opportunity to get out closer to their initial entry point. Conversely, those who missed the move might see the gap fill as a second chance to enter at a favorable price. 2. Technical Analysis and Support/Resistance:
Areas of Inefficiency: Gaps are often seen as areas of price inefficiency. There were no trades executed within the gap range. Technical analysts believe that markets tend to fill these inefficiencies over time as supply and demand forces reassert themselves. Potential Support or Resistance: The edges of a gap can act as potential support (for an upward gap) or resistance (for a downward gap) levels. When price approaches these levels, there can be increased buying or selling pressure, respectively, potentially leading to the gap being filled. Pattern Completion: Gap fills can sometimes be part of larger technical chart patterns. For example, a gap might occur within a trend, and the subsequent fill could represent a temporary pullback before the trend resumes. 3. Fundamental Reasons (Delayed Reaction or Information Catch-Up):
Initial Overreaction: Sometimes, the initial reaction to news or events can be an overreaction. As more information becomes available and the market has time to digest it, the price might retrace to more accurately reflect the fundamental value, potentially filling the gap. Institutional Buying/Selling: Large institutional investors might have specific price targets or strategies that involve filling gaps. They might gradually accumulate or distribute shares within the gap area, eventually leading to its closure. 4. Algorithmic Trading:
Pre-programmed Strategies: Algorithmic trading systems are often programmed to identify and trade based on technical patterns, including gaps. These algorithms can contribute to the filling of gaps by automatically placing buy or sell orders as price approaches the gap area. Why the Delay (Sometimes a Year or More)?
Market Sentiment and Trend: The prevailing market sentiment and the overall trend of the stock or the broader market play a significant role. A strong uptrend might prevent a downward gap from filling for a long time, and vice versa. Lack of Catalyst: There might not be a specific catalyst or event that drives the price back to the gap area for an extended period. Shifting Focus: The market's attention might shift to other factors and news, leaving the gap as an unaddressed anomaly for a while. Strength of the Initial Move: A very strong and fundamentally driven gap might take longer to fill because the underlying reasons for the gap remain valid for a longer period. Important Considerations:
Not All Gaps Fill: It's crucial to remember that not all gaps get filled. Some gaps, known as "runaway gaps" or "measuring gaps," can indicate strong momentum and may not be revisited for a very long time, if ever. Context Matters: The significance of a gap and the likelihood of it being filled depend on the context, including the volume during the gap, the reason for the gap, and the overall market conditions. Trading Strategy: While gap filling can be a part of some trading strategies, it shouldn't be the sole basis for trading decisions. It's essential to consider other technical and fundamental factors. In summary, the tendency for gaps to be filled is a result of a combination of psychological factors (market memory, regret, opportunity), technical analysis principles (inefficiency, support/resistance), fundamental adjustments (overreaction, information catch-up), and the influence of algorithmic trading. The time it takes for a gap to fill can vary greatly depending on the strength of the initial move, overall market conditions, and the presence of catalysts.
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