In this post we are going to cover how to effectively use a gap scanner to find potential trades in the market, and cover some examples of strategies that can be employed to take advantage of stocks that gap up in the market.
How to Trade with Gap Scanners Like a Pro
In the following we will seek to educate retail traders and investors on the basics of how to employ a gap scanner to help find trades that will match your particular trading strategy with examples. Lets get started!
What is a Gap Scanner?
Gap scanners are search engines that allow traders to scan the markets for specific stocks that match their criteria in order to find potential stocks to trade.
Those of you who are considering gap trading would be well-advised to use a pre-market gap scanner and search for stocks that meet criteria specifically for gap trading. We will examine this criteria in more depth below.
Examples of Gap Scanner
There are plenty of gap scanners available online. You can find well-regarded and widely used scanners at www.tc2000.com amongst many other websites.
I personally prefer TC2000 because of their low pricing and great charts, which makes it a good 2 for 1 deal if you want both a great customizable gap scanner and a great charting platform.
For anyone who is not able to access either of these scanners, you can find a free scanner with delayed data at www.finviz.com.
What Does Gap up Mean in Stocks?
A gap up in stocks is formed when the opening price of the following day’s regular cash session is greater than the closing price of the previous day’s session.
This difference in price creates a “gap” in the price levels of a stock. In the example below, you will see stock ticker ATER gapping up and opening higher than its previous days trading session.
ATER closed at $11.84 on 90/10/2021 and gapped up to (opened at) $11.84 the following day.
What does a Gap Down Mean in Stocks?
A gap down in stocks is formed in a similar fashion as a gap up except that the opening price of the following day’s regular cash session is lower than the previous closing price.
You can see in the image below BLIN gapped up from $8.50 to about $14.00 per share on July 6th, 2021 and it gapped down from its close on July 6th at $12.21 to $10.00 the following day.
BLIN Gap Down Example
How to set up a Gap Scanner?
The first step in setting up your gap scanner will be to decide on which scanner is best for you to use.
We have provided some examples above to choose from, or you may decide on a different scanning solution that better suits your specific needs and preferences.
Once you have decided on a scanner, you will need to define the parameters within which it operates.
Since your gap scanner is only as useful as the parameters within which it operates, here are some suggestions for your gap scanning criteria.
- At least 100,000 shares traded by 9 AM.
- Average daily volume over 500,000 shares.
- A gap of at least 10% in pre-market.
- Stocks that have an Average True Range (ATR) of at least 50 cents
Once you have your parameters set up, sort the gap scanner by top % gainer to see the highest gapping stocks each morning in premarket and then begin looking the charts of those stocks to determine which has the best pattern, volume, and catalyst for a potential move higher in the morning.
How Do You Know if a Stock Will Gap Up?
Individual stocks can be highly unpredictable in the short term and knowing if a stock will gap up can be tricky.
Despite the unknowable nature of stocks, there is a range of factors that you can look for to gauge the probability of whether or not a stock will gap up.
A positive catalyst is essential for a successful gap up, so you will be looking for stocks that have had some positive news that might support a gap up in the stock.
The opposite is also true for a successful gap down, a negative catalyst will be required. You can use sites like www.yahoofinance.com to keep up with the latest news and research potential trade candidates.
Another characteristic in assessing whether a stock will gap up is the current float of the stock.
Stocks with low float have a limited supply of shares available on the markets and so they are fantastic candidates for potential gap ups as they are more likely to experience significant volatility.
Whilst there is no concrete definition of what exactly constitutes a low float, anything under 20 million shares in the float should suffice.
The most important indicator to monitor when determining if a stock is going to gap up will be its volume. Any meaningful move in a stocks price will require significant volume to achieve.
Remember that volume, like most of aspects of trading in the financial markets, is relative. What is high volume on one stock may not necessarily be considered high volume for another.
Ensure that volume is higher than usual for the specific stock that you are trading.
Strategy for Trading Gaps
Trading gaps in the morning is popular among those who do not trade full-time and have other professional commitments as it only requires that you be available during the pre-market and market open hours.
You would spend the pre-market using your gap scanner to identify possible trade setups and then enter your positions at market open or slightly after the market opens.
Ideally, traders who use this strategy will have secured their profits and closed their positions within an hour of the market open.
I personally don't condone buying a stock right at the open, I think its imperative for day traders to wait at least 15 mins after the open until the stock has set a clear trend, risk levels, and a repeatable pattern to signal an entry into the stock with a good risk vs reward scenario.
The goal of this particular continuation strategy is to take advantage of the price gaps by entering either buy or sell positions.
If you believe a stock will gap up due to a recent fundamental catalyst, you would enter a buy position and capitalize on the increase in the price of that stock.
Alternatively, if you believed that a stock is likely to gap down due to a negative event or data release, you would enter a short position and profit from the fall in the stock's price.
Essentially, traders employing this strategy are looking to benefit from the continuing momentum in a stocks price action. Let’s take a look at how we can use the gap and go strategy in practice.
How do You Trade the Gap?
The first step in this strategy is to identify stocks that have the necessary characteristics to trade. For example, you may want to filter your stock scanner to screen for stocks that are up more than 10% from their previous days close.
You can also include criteria such as:
- Above Average Volume
- Positive Earnings
- Above Moving Averages
If using a scanner like TC2000 or Finviz, you can easily add any criteria you want to filter for the stocks that meet the criteria you are looking for in your day trading or investing strategy.
For the purposes of this post, lets say you are looking for stocks that have gapped up more than 10% from yesterdays close and want to play a long side continuation after the bell.
Researching Gap Stocks
After your gap scanner has highlighted some stocks that match your criteria, it is time to begin your research into the stock in an effort to narrow down the best candidates.
You will be primarily looking for catalysts that would support the gap in price as well as some other indicators like volume, candlestick chart patterns, etc.
Assume that your gap scanner has identified a gap in NNVC's stock. Its at the top of the pre-market gainers list and doing above average volume.
At this point, you would go online to find news that may account for this gap. Upon researching various financial sites you discover that NNVC had a fantastic earnings release after the previous market close and smashed Wall Street estimates.
This would qualify as a suitable reason for the gap up and so, provided all other indicators are aligned with this news, would qualify NNVC as a potential gap and go trade.
Once you have used your pre-market gap scanner to identify stocks that are in play and have filtered down your watch list to the candidates most likely to succeed, you are ready to begin trading.
Waiting for the Trend to Be Established
Fools rush in! It is advisable that traders wait about 15 minutes after the open before entering their positions as there is usually a complicated mess of mass psychological trading unfolding at the open for gap stocks.
You want to see a clear support level form on the stock that can be used as a risk level, and a breakout level that you can buy for a continuation higher.
In the example below, the stock NNVC gapped up significantly from the previous days close. After an opening push and about 15 minutes of morning trading action, it established some support at $5.60 and broke out through $5.90.
Gap Trading Example
In this scenario, the trader could buy the breakout through $5.90 with a stop loss at the $5.60 support and play it for a "gap and go" move higher in the morning taking profits into the breakout.
How Gaps Affect the Way a Stock Trades
If a stock has gapped up, some overnight traders start closing their positions for a profit. At the same time, newer investors might decide to buy the stock before the price goes higher.
On the other hand, If a stock gaps down, some investors might panic and dump their shares at the open before it drops any lower.
Institutional investors may also believe that this drop could present a good buying opportunity and start purchasing large positions for what they believe to be a discounted price.
The wisest traders will therefore sit on their hands and watch for the opening ranges to develop and allow the other traders to fight against each other until one side wins out over the other. A crucial price movement to keep an eye on during this time will be the pullback.
If the stock you are monitoring gaps up and then proceeds to sell off whilst remaining under its opening price, it is highly likely that the stock has reached its high for the day.
However, if that same stock were to gap up and then pullback but proceed to rally and beak above its opening price, the stock is highly likely to make new intraday highs.
As a general rule, gaps in bull markets tend to perform best when the gap was near the yearly high whilst gaps in bear markets seem to perform best when they are near their yearly lows.
The larger the gap the better that stock is likely to perform.
Risk management is a vital practice for every successful trader and so determining where to place your stop-loss order will be crucial.
When gap trading, the lower rim (for uptrends) or the higher rim (for downtrends) of a gap is a good place to put a stop-loss order.
Gaps provide near-term support or resistance, so this stop-loss placement works well with those gaps that do not close quickly.
In the example with NNVC above, it shows on the chart where support had been formed to set risk, and where the breakout level was for the buy trigger to enter the trade.
It is crucial to always follow a proper risk management plan and exercise discipline and proper position sizing to ensure long term success in your trades.
Trading is a game of numbers. If your strategy has a 70% winning rate, your success really comes down to risk management and how you handle the losing trades.
For more on risk management and proper trade planning, please see this free video lesson to learn how I implement a bulletproof risk management system into my trading.
Gap Trading Fundamentals
If you plan to hold any stocks overnight assuming a gap up the next day, you will want to make sure that there are no underlying negative fundamentals.
Things like potential offerings / dilution of shares, or upcoming news releases could have a negative impact on the following days opening price of a stock.
Holding speculative penny stocks and small cap stocks overnight is very risky as there are many fundamental factors that could lead to a gap down the following day.
The biggest risk, for example, is that if the stock gaps down then it may gap down below your planned stop loss area the following day.
For this reason, we prefer to wait for the stock to gap up in the morning and then watch for a continuation pattern to form that can offer a low risk entry point with a clear stop loss support area to trade from, and close the position out by end of day.
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