Why Liquidity Gaps Matter in Trading
What is a What is a liquidity gap?
A liquidity gap occurs when the price of a security moves quickly through a price level, either up or down, with little trading or pricing available over that time span.
In volatile markets, traders can benefit from large jumps in asset prices if they can be turned into opportunities.
Gaps are areas on a chart where the price of a stock (or another financial instrument) moves sharply up or down, with little or no trading in between.
As a result, the asset’s chart shows a gap in the normal price pattern. The enterprising trader can interpret and exploit these gaps for profit.
How they are formed
Liquidity Gaps can be caused by several factors, but they are mostly seen as a result of unexpected news or a technical breach of support or resistance.
- On the fundamental side, the news could be a company beating earnings estimates by a large margin, or a speech by a Federal Reserve (Fed) official impacting interest rate expectation.
- On the technical side, gaps can ensue following the break of a prior high/low, or other form of technical resistance or support, such as a key trend line.
Key Takeaways About Liquidity Gaps
- Gaps are spaces on a chart that emerge when the price of the financial instrument significantly changes,with little or no trading in between.
- Gaps can occur unexpectedly as the perceived value of the investment changes, due to underlying fundamental or technical factors, such as an earnings disappointment.
- Gaps are classified as breakaway, exhaustion, common, or continuation, based on when they occur in a price pattern and what they signal.
