Good response from noretreat.
Let me just recognize the 800 pound gorilla in the room. Gaps occur for reasons, and they fill or exacerbate trends based on underlying fundamentals in the long-term. In the short-term these disruptive events add volatility.
I don't know statistically what percent of gaps fill. But; from personal observation, it looks to be very high, both for gap downs and up. Also, from observation, it appears gap ups are more sustainable in the medium-term. Gap downs often take longer to recover (again from observation).
I like to use the expression, "getting more than one chance at biting the apple". Looking at many charts, it seems most gaps fill. But then what? But, how long? Does the gap become resistance/support, or does the established trend continue? Again; from observation, it appears to be a mixed bag. This is where an underlying understanding of the stock and the company becomes helpful.
What is the chart saying? Major gaps are usually created when the market is caught off guard (unexpected news, corporate developments, news outside the company which affects the industry/market), sometimes when trading is thin (market closed, after/before market, weekends/holidays). Minor gaps are typical and may not mean a thing.
Investors would probably benefit from correctly understanding what was happening prior to the gap. Was the stock in a normal cycle--all stocks go up and down? Was the stock trending because of improving or deteriorating fundamentals?
I would suggest that a stock trending in the direction of the gap based on fundamentals is more likely to continue the trend after the gap fills. Thus the gap becomes a top/bottom and resistance/support. Honestly, charts can go independently of underlying fundamentals short-term, but over the long-term its fundamentals that are likely to rule the day. Still, being patient for the gap to fill is often a good strategy.
What matters? Longer-term it all depends on whether the market got the gap event right or wrong. Obviously, a stock with deteriorating fundamentals hit with unexpected bad news may recover, but then likely continue its original downward trend. Dissimilar to this scenario, stocks cycling and then gapping are likely to follow fundamentals. Often times old news is drudged up as news and the market reacts. Was the new old news already factored into the price before the gap? When the stock regains equilibrium, will it be back where it started and waiting for the next bit of fundamental change?
So, not all gaps are created equally. I think it is important to really understand the stock and company and market environment. Good company, good fundamentals (company development and unfactored news--new news), a gap down, not much of a worry long-term (I think this is the NNVC story). Deteriorating fundamentals, a gap down, gap refills, time to get out.
Major gaps, most often create trading opportunities. Volatility usually leads to oversold and overbought situations. Some can profit from the emotions expressed in the market.
Just my personal thoughts and observations.
I am always looking for fundamentals and trading patterns (charts) to be in or out of step with one another. Divergent fundamentals (earnings/outlook/corporate development/news) and market signals (price/momentum/quantity) can lead to trading opportunities. Easier said than executed. It takes work, and one can still be wrong.
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