Runaway Gaps Definition and Trading Strategy

Runaway Gaps: Definition and Strategies for Trading

Runaway gaps are not just arbitrary voids on a chart; they are pivotal in trend analysis for any trader. Promptly spotting and accurately interpreting runaway gaps, also known as the “runaway gap,” can mean the difference between riding a trend or missing out. This article directly addresses how to recognize runaway gaps and their significance in active trading, setting you on a path to make informed decisions based on these critical chart indicators.

Furthermore, we’ll give you statistics, numbers, data, performance metrics, and facts, which we did by backtesting. Hopefully, you will get more knowledge than from other websites’ traditional anecdotal and boring descriptions.

Runaway Gaps Definition and Trading Strategy

Key Takeaways

  • A runaway gap, or continuation gap, signals strong investor interest and often occurs during strong trends, perpetuating the likelihood of their continuation, and is usually supported by high trading volumes.
  • Runaway gaps differ from other types of gaps, such as common and exhaustion gaps, in that they indicate continued trend momentum and are less likely to be quickly filled.
  • Profitable trading of runaway gaps involves early identification during a strong trend, careful monitoring of trading volume, and effective risk management through stop-loss orders.
  • We provide historical evidence, statistics, data-driven numbers, facts, and performance via backtesting.

What is a Runaway Gap in Technical Analysis?

A runaway gap, or continuation gap, is an event on a price chart where trading activity jumps over previous price points or after consolidations, often due to high investor interest.

Here is a visual chart showing two examples of runaway gaps (in a long term bullish trend – not shown):

Runaway gap example
Runaway gap example

These gaps usually occur during strong bullish or bearish trends and are characterized by a significant price change in the direction of the ongoing trend. They can reinforce the direction of the trend and often arise after a breakaway gap, increasing the probability of continuation due to unexpected news or events that support the trend.

The psychology behind a runaway gap suggests that traders, who missed the initial trend movement, enter the market in large numbers. This rush to avoid missing out on the perceived trend causes a rapid price change. This is a common trading bias in the markets, and partially based on the FOMO (Fear Of Missing Out) principle.

Runaway gaps are often associated with high trading volumes, indicating strong investor support for the price move and confirming the trend’s momentum.

In a trading cycle that includes breakaway and runaway gaps, such as breakaway gaps, runaway gaps, and exhaustion gaps, runaway gaps appear during the trend and serve as additional evidence of the trend’s validity.

Are Runaway Gap different from other types of Gaps?

Runaway gaps are different from other types of gaps because the gap in the same direction as the underlying long-term trend. Breakaway gaps happen when they break out of a pattern, while exhaustion gaps are reversal patterns.

Runaway gaps, or continuation gaps, often materialize during a trend, indicating a strong likelihood of its persistence. These gaps are significant indicators in trend analysis. This type of gap typically sees trading activity skip sequential price points due to intense investor interest, indicating a strong sentiment in the direction of the trend. Unlike common gaps, which tend to get filled quickly and occur with average trading volume, runaway gaps often appear with high trading volume.

In contrast to breakaway gaps, which occur at the start of a new trend and are associated with a price moving out of a trading range or chart pattern, runaway gaps are indicative of the middle phase of a trend.

Unlike runaway gaps, exhaustion gaps signal the end of a trend and are characterized by a rapid price movement that is likely to reverse, which is different from the trend continuation signal of a runaway gap.

Is Runaway Gap important?

A runaway gap is important because it signals that the long-term trend remains intact.

The formation of runaway gaps is a result of trading activity bypassing sequential price points due to heightened investor interest, often furthering the direction of a trend. These gaps, characterized by a significant price change in the direction of the prevailing trend, serve as micro-insights for technical traders, offering gap signals over short periods of time.

Traders often view runaway gaps as confirmation of a trend’s strength, as they usually occur after a breakaway gap and are typically associated with high trading volumes. The psychology behind a runaway gap suggests that traders who missed the initial move become eager to join the trend, leading to a rush of buying or selling that results in the gap formation.

The occurrence of a runaway gap during a trend is a signal that the price breaks are likely to keep moving in the direction of the gap within a few weeks, or sometimes even within days.

Mastering Runway Gap

How to find Runaway Gaps?

You find runaway gaps by making trading rules for it and scan the market for this pattern.

Runaway gaps are typically evident on stock charts when trading activity bypasses sequential price points due to high investor interest, leaving no trading between the gap’s start and end. Market technicians suggest that runaway gaps often occur after a security has experienced a breakaway gap, as the likelihood of trend-reinforcing events increases.

To spot runaway gaps in technical analysis, traders look for a substantial price difference between two consecutive trading sessions, without trading activity closing the gap. In an uptrend, a runaway gap is identified by an upward price gap, indicating increased buying pressure and bullish sentiment.

Conversely, in a downtrend, a downward gap signifies increased selling pressure and bearish sentiment.

Are runaway gaps profitable?

Runaway gaps are profitable, but it depends on what kind of trading rules you are using. We use quantified trading rules and find runaway gaps to be profitable in the stock market.

Please look at the next section, where we backtest a specific trading strategy:

Runaway gap trading strategy

Let’s give you an example of a runaway trading strategy for educational purposes:

We make the following trading rules:

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We use one long-term filter to ensure we are in a bullish market and a short-term filter to signal a runaway gap.

Applying these trading rules on Tesla gives us positive returns for every trading day over the next 12 days. If we exit after 12 days, we get the following equity curve since Tesla’s listing:

Runaway gap trading strategy
Runaway gap trading strategy

There are not many trades: 51. However, the average gain is 4.9% per trade, and the win ratio is 57%. It’s a low win ratio, but we make up for it by having many big winners and losers that are, on average, smaller.

Please be aware that this backtest might be liable to survivorship bias because we have picked Tesla because it has been successful after it was listed on the exchange. Applying the same trading rules on a broad market index like S&P 500 yields worse trading performance metrics. That is to be expected, though, because such a broad index tends to revert to the mean more frequently than single stock tickers.

Characterized by a substantial price shift in the direction of the prevailing trend, a runaway gap appears amidst robust bull or bear movements. Trading runaway gaps involves recognizing these gaps in the midst of a trend and interpreting them as signs of strong market sentiment in the trend’s direction.

While trading runaway gaps, considering the market’s psychology is crucial since the gap could highlight traders’ readiness to participate, leading to swift price fluctuations. To trade runaway gaps, one should monitor for high volume accompanying the gap, which indicates a strong trend continuation signal. Setting a stop-loss order just below the runaway gap can help manage risk as it provides a safety net in case the gap is closed and the trend reverses.

What is a different name for Runaway Gaps?

A different name for runaway gaps is continuation gaps (or even measured gaps have been used by some traders). However, in practice, these two are pretty similar.

What is the difference between a continuation gap and a runaway gap?

Continuation Gap VS Runaway gap

The difference between a continuation gap and a runaway gap is that continuation gaps tend to be followed by a new price pattern, while a runaway gap is likely to continue without forming a new technical pattern.

Runaway gaps, also known as continuation gaps, occur in the middle of a price pattern and signal a rush of buyers or sellers who share a common belief in the underlying stock’s future direction.

Continuation gaps are typically followed by a new price pattern, indicating the continuation of the previous trend, whereas runaway gaps suggest a strong trend that is expected to continue without the immediate formation of a new price pattern.

A continuation gap occurs when the price of a security resumes its trend after a brief consolidation, while a runaway gap is typically characterized by a price leap in an already strong trend without a prior consolidation phase. Runaway gaps are often accompanied by high trading volume and can indicate strong investor interest, pointing to potential continuation of the trend. In contrast, continuation gaps may not always show a significant increase in volume.

Are Runaway Gap common?

Runaway gaps are not common. For Tesla, a bullish runaway gap happens circa 1.5% of the time – about 3-5 times a year.

This is not often, so you need to apply the trading rules on many stocks to make effective use of your trading capital. However, it depends on the trading rules you are using.

Runaway gaps, a type of price gaps, occur more often in financial markets that are experiencing strong movement, as investors’ excitement or anxiety increases. This can lead to gaps between trading sessions. During periods of market euphoria or fear, these types of gaps tend to be more prevalent as traders and investors demonstrate stronger conviction. This often leads to more pronounced fluctuations in market prices.

The frequency of runaway gaps is influenced by the timescale being studied; they tend to be less frequent on shorter timescales like hourly charts than on longer timescales like daily or weekly charts.

How do you trade runaway gaps?

There are no hard rules for how to trade runaway gaps. You need to make your own trading rules and backtest those to find the historical statistics and evidence of the past performance. It’s no guarantee of profitable future performance, but we believe it’s the best path to becoming a profitable trader.

However, the optimal time to trade a runaway gap is during its early formation stages, which is when the gap signifies a robust continuation of the existing trend. Trading a runaway gap effectively involves entering a position soon after the gap appears to capitalize on the expected continuation of the trend and maximize potential profits.

A trader should confirm that the runaway gap remains unfilled after a few candles, which demonstrates sustained directional conviction before entering a trade.

Most traders like to set stop losses when they are trading. We have backtested stops for decades and how found them to deteriorate a trading strategy. There are better risk management tools than a stop loss. Please read this article for alternatives to a stop loss.

What is the difference between a runaway gap and an exhaustion gap?

The difference between a runaway gap and an exhaustion gap is that a runaway gap is a continuation pattern, while an exhaustion gap is a reversal pattern.

Runaway gaps are a type of price gap found on price charts that occur in the middle of a price trend and signal that the trend is likely to continue. It’s based on trend following.

In contrast, exhaustion gaps occur after a rapid rise or fall in a stock’s price over several weeks and signal a potential end to a trend. It’s based on mean reversion.

A runaway gap occurs when it is also known as a measuring gap or continuation gap, and it typically does not get filled as quickly as other types of gaps, such as the common gap, because it indicates a powerful trend is in play. On the other hand, an exhaustion gap usually occurs with higher volume and is quickly filled as it indicates that the prevailing trend is running out of momentum and a reversal may be imminent.

Do Runaway gaps get filled?

Most runaway gaps get filled, but they are much less likely to be filled as, for example, exhaustion gaps. Statistics from backtests reveal that about 50% of the runaway gaps get filled within two months.

However, bullish runaway gaps are less likely to get filled than bearish runaway gaps.

Runaway gaps are less likely to be filled soon after they occur due to strong market trends and high trading volumes that support the direction of the gap. The occurrence of runaway gaps is often driven by intense investor interest, leading to a rapid price change in the direction of the trend, which can make them remain unfilled for an extended period.

The psychology behind runaway gaps suggests that traders are eager to join the trend and may enter the market in large numbers, further reinforcing the trend and keeping the gap open. Runaway gaps can occur during both bullish and bearish trends and are typically associated with significant price moves of 5% or more, which can make them more resilient to being filled quickly.

What is the psychology behind Runaway Gaps?

The psychology behind runaway gaps is shaped by traders who miss the initial move and grow impatient waiting for a retracement (FOMO), leading to their simultaneous entry into the market. Runaway gaps reflect a sense of urgency or even panic among traders to participate in a trending market, which can be triggered by unexpected news, resulting in a sharp price movement.

Traders’ eagerness to enter the market during a runaway gap can lead to high trading volumes and the gap itself, as market makers are forced to adjust bids and offers significantly away from the last traded price. Runaway gaps often occur after a breakaway gap, suggesting an increased probability of an unexpected event that can further propel the existing trend.

Are there trading strategies that can be associated with Runaway Gaps?

Trading strategies that can be associated with runaway gaps are trend strategies. Both seek to capitalize on the underlying trend, either bullish or bearish.

One strategy linked with runaway gaps involves purchasing a stock after trading hours when a favorable earnings report is released, in anticipation of a gap up on the subsequent trading day. Traders may also buy or sell into highly liquid or illiquid positions at the beginning of a price movement, with the expectation of a good fill and a continued trend, especially when a stock is gapping up quickly with no significant resistance overhead.

Some traders employ the strategy of fading gaps in the opposite direction once a high or low point has been determined, often using other forms of technical analysis to guide their decision.

Another strategy is purchasing the stock when the price level reaches the prior support after the gap has been filled, capitalizing on the market’s return to a previous price level.

What time is the best to trade Runaway Gap?

The best time to trade a runaway gap is during its early formation stages, which is when the gap signifies a robust continuation of the existing trend.

Trading a runaway gap effectively involves entering a position soon after the gap appears to capitalize on the expected continuation of the trend and maximize potential profits.

Are Runaway Gaps Reliable Indicators?

Runaway gaps are not reliable because the 50% win rate is low. Few big winners make up for the losers. Conversely, exhaustion gaps have a higher win rate because they are based on mean reversion, a type of trading strategy with a higher win rate.

In technical analysis, runaway gaps are recognized as potent continuation signals, indicating a swift and considerable shift in market sentiment, often spurred by significant fundamental or technical elements. The appearance of a runaway gap suggests an abrupt increase in buying or selling pressure, indicating a substantial shift in market sentiment and providing traders with insight into the strength and velocity of the trend.

Runaway gaps are typically accompanied by higher volatility and momentum in the direction of the gap, with greater trading volume as fresh money pours into the asset. While runaway gaps are seen as reliable indicators of trend continuation, they should not be considered 100% reliable on their own and are best used in conjunction with other technical indicators and analysis.

What is the risk with Runaway gaps?

The risk with runaway gaps is that they are unreliable; thus, you might experience many consecutive losing trades with the risk of abandoning an otherwise successful trading strategy.

Also, runaway gaps might not be filled as frequently as other gap types, potentially leading traders to mistakenly presume that a new trend will persist without a retracement. When fresh information becomes available, or market conditions change, runaway gaps can close, potentially resulting in significant losses for traders who acted on the initial gap.

Increased price swings and volatility following a runaway gap can lead to greater risk exposure, especially for traders not employing proper risk management techniques. Traders may misinterpret a runaway gap as a continuation of a trend when it could be a warning sign of market exhaustion, leading to mistimed entries or exits.

Are Runaway gaps profitable?

Runaway gaps are profitable, but it depends on your trading rules. You need to backtest to make sure it has yielded positive returns in the past. That is no guarantee of future profits, but it’s a good start.

Runaway gaps, alternatively known as continuation gaps, can indicate a surge of buyers or sellers, who hold a collective belief about the underlying stock’s future trajectory, thus presenting a trading opportunity.

Summary

In summary, runaway gaps are significant indicators in technical analysis. Armed with an understanding of their characteristics, implications, and the strategies to trade them, traders can potentially find profitable opportunities,like we did in this article.

Remember, the key is in the right timing, understanding of market context, and effective risk management. You need to formulate trading rules based on all these factors.

Frequently Asked Questions

Do runaway gaps get filled?

Runaway gaps may not always be filled, as they signify different market conditions and implications for strategy and risk management. Therefore, the adage that all gaps eventually get filled might not hold true for these types of gaps.

What is the difference between a breakaway gap and an exhaustion gap?

The main difference is that exhaustion gaps signal the end of a price trend and are often filled, while breakaway gaps confirm the direction of a trend and are less likely to be filled in.

What is the difference between a continuation gap and a runaway gap?

A continuation gap, also known as a runaway gap, occurs in the middle of a price pattern and signals a rush of buyers or sellers who share a common belief in the underlying stock’s future direction. This type of gap must be accompanied by an increase in volume for the prevailing trend to continue.

What are the 4 types of gaps?

There are four main types of price gaps: common gaps, breakaway gaps, runaway gaps, and exhaustion gaps. Each type carries its own signal to traders.

What is a runaway gap?

A runaway gap is a price disparity in chart patterns that signals the continuation of an existing trend. It is a significant indicator of market direction.

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