Gaps and Windows are one in the same. The term 'gap' is the Western term that we see and hear about in our media. The term 'window' is used in Japanese teachings - as, "it offers a window in the chart of which to see through".
A Gap is basically an area that is open in price in which there were no trades. This most often occurs between the timings of a market close and the follow day's open.
There are many reasons that can cause this, such as an earnings report released after the stock market has closed for the day. If the earnings were significantly higher than expected, many investors tend to place buy orders for the next day. This could result in the price opening higher than the previous day's close.
If the morning price then continues to trade above the previous closing price, a gap will form in the price chart. Gaps offer evidence that something important has happened to the fundamentals or the psychology of the traders in a particular stock.
A gap can also occur during the trading day, particularly from the time a stock is halted from trade - and the time it is later reopened. This is almost always the result of a significant news announcement pending for release.
There are at least four types of gaps that technicians search for when analyzing charts. These are Breakaway gaps, Common gaps, Continuation/Runaway gaps, and Exhaustion gaps.
Breakaway Gaps generally signal a reversal in price. They can occur after a consolidation or at the end of a trading range, and move in the opposite direction of the previous trend. These are the exciting moves that we often see talked about on CNBC all day long. BRCM shown just below is well known for its upside and downside Breakaway Gaps.
Volume, as a result of the excitement created, will generally pick up significantly. This is not only for the increased enthusiasm, but from the effects set in motion by traders/investors who are holding positions on the wrong side of the breach - and need to cover or sell them. This creates additional market strength in the direction of the new trend.
It is important to note that not all gaps are bought or sold into.
A Common Gap usually appears inside a larger trading range or congestion area, and reinforces the apparent lack of interest or uneventfulness of a gap in the stock. Many times this is further exacerbated by low trading volume and a stock going ex-dividend. Being aware of these types of gaps will help, because they rarely will produce a good trading opportunity. These gaps are quickly filled or don't get far away from their openings for days.
Continuation or Runaway Gaps can attribute their momentum to true increased interest in the trade. The theory behind an upside continuation gap is that traders who did not get in during the initial move of the uptrend, and never were offered a retracement in price, decide to buy along the way. The opposite effect would work in a downside continuation gap.
With volume and price both moving higher, the continuation gap represents an almost panic state in traders, as many begin to chase the price. This further drives momentum.
It is also worthy to point out that a significant news release, whether positive or negative, should be known or researched for if this type of strong move is noted. A trader needs to be informed of why this happened.
This chart below of FSLR absolutely destroyed shorts during a rally of 108 points. The gap came with solid volume and moved aggressively higher. The rally began after blow-out earnings were released, leaving Shorts screaming and forced to cover. This in turn assisted the rally.
Exhaustion Gaps are those that occur near the end of a solid uptrend or downtrend. Many times, these signal the finality of a long momentum move. They are accompanied by exceptionally high volume, and can easily be mistaken for a runaway gap if one does not notice volume properly.
One way to spot an exhaustion gap, is that the gap is then quickly filled as price reverses on the secondary move. The gap originates higher with massive volume, then, there is significant profit taking and the demand for the stock totally dries up. Prices drop, the gap is lost to the opposite side, and a significant change in trend occurs.
Exhaustion gaps can be easy to trade and profit from. The volume should be the first key that it is either an exhaustion gap or a continuation gap. You are looking for a large gap in size and volume that nearly or more than doubles the average from the exhaustion gap. This is caused by mass order-flow of either sellers or shorts covering, depending on where the gap happened in the trend.
