ACCENT JOURNAL OF ECONOMICS ECOLOGY & ENGINEERING
Peer Reviewed and Refereed Journal, ISSN NO. 2456-1037Available Online: www.ajeee.co.in/index.php/AJEEE A STUDY OF GAP THEORY AND ANALYSES OF PRICE GAPS IN INDIAN STOCK
MARKETS
1Ms. Sona Parani, 2Mr. Mohit Raikwar
1,2Assistant Professor, IMIRC, Indore
Abstract:- This paper analyses price gaps in Indian stock markets. Study of gaps theory indicates that the present day’s opening price isn't an equivalent because the previous day’s price. The sample period went from April 2020 to April 2021. Analysis a range of gaps, we studied different results and are ready to show that in most cases the observed price behavior isn't inconsistent with market efficiency. This paper aim to determine whether such an anomaly are often exploited to form abnormal profits, which might represent evidence against the EMH and study that common sayings by traders is that “Gaps always get filled” the market abhors a vacuum and all gaps are filled
1. INTRODUCTION
Price charts often have blank spaces called gaps, which represent times when no shares were traded within a specific price range. Normally this happens between the close of the market on someday and therefore the next day's open. There are two primary types of gaps - up gaps and down gaps.
For an up gap to make, the low price after the market closes must be above the high price of the previous day. Up gaps are generally considered bullish. A down gap is simply the opposite of an up gap; the high price after the market closes must be below the low price of the previous day. Down gaps are usually considered bearish.
Gaps result from extraordinary buying or selling interest developing while the market is closed. As an example, if an income statement with unexpectedly high earnings comes out after the market has closed for the day, tons of buying interest are generated overnight, resulting in an imbalance between supply and demand. When the market opens the next morning, the value of the stock rises in response to the increased demand from buyers. If the value of the stock remains above the previous day's high throughout the day, then an up gap is made.
Gaps offers evidence that something important has happened to the fundamentals or the psychology of the group that accompanies this market movement.
2. TIMEFRAME OF GAPS
Up and down gaps can form on daily, weekly or monthly charts, and are considered significant when accompanied with higher than average volume.
Gaps appear more frequently on daily charts, where daily is a chance to make an opening gap. Gaps on weekly or monthly charts are fairly rare: the gap would need to occur between Friday's close and Monday's open for weekly charts, and between the Judgment Day of the month's close and therefore the first dayof subsequent month's open for monthly charts.
A price chart with gaps almost daily is typical for very thinly-traded securities and will be avoided. Prices often gap up or down at market open, but the gap doesn't last until the market closes. Such temporary intraday gaps shouldn't be considered as having any longer significance than normal market volatility.
3. GAPS & GAP ANALYSIS 3.1 Gap
A gap is a section on a price chart in which there have been no trades. Price gaps both to the upside and downside, and it can happen in any time-frame. Gaps commonly appear on daily price charts, but they are also present on minutes, hourly and tick charts, as well as long term charts like weekly charts.
Common sayings by traders is that “Gaps always get filled” the market abhors a vacuum and all gaps are filled. While this might have some merit and demerits.
Figure 1: A: Gap Up and Gap Down
Gaps appear more frequently on daily charts, where daily is a chance to make a gap gap. Any significant news that relates to the sectors, industry, index or individual stock or commodity can result in a price gap. Stocks regularly gap on earnings announcements, merger and on managerial shake-ups. Gaps are frequently amid a rise in volume.
Gaps can only be observed on the candlestick chart or the bar graph. A technical analyst making use of a line chart wouldn't be ready to spot a gap as all the points tend to be connected.
For e.g. Gap can be witnessed on a Nifty candlestick chart
Figure 2: B: Nifty Bank Streaming Chart
ACCENT JOURNAL OF ECONOMICS ECOLOGY & ENGINEERING
Peer Reviewed and Refereed Journal, ISSN NO. 2456-1037Available Online: www.ajeee.co.in/index.php/AJEEE 3.2.1 Common Gaps
Sometimes mentioned as a trading gap or a section gap, the common gap is sometimes uneventful. This can be also called filling the gap. After the gap the costs have come down to at least the start of the gap this is often called closing or filling the gap. Common Gaps are commonly found on a price chart and acquire filled within a number of days or few weeks. By saying filled, we mean that the gap gets closed as price retraces back into the gap zone. They could result due to a stock going ex-dividend. They can be caused by a stock going ex-dividend when the trading volume is low. In future contract you will find a gap that is also consider in common gaps. New share issues.
A common gap usually appears in a trading range or congestion are and reinforces the apparent lack of interest within the stock at that time.
Common gaps also will occur in conjunction with other technical chart pattern like triangles and wedges.
Common gap usually fill in small time like for the daily trade chart , it'll fill between one or two days.
Figure 3: Candlestick Streaming Chart Showing Common Gap Usually Fill 3.2.2 Breakaway Gaps
As the name suggests, Breakaway Gaps are those gaps on a price chart that occur after price breaks out of a congestion zone or trading range. These breakouts or breakdowns are usually related to a rise in volume and don’t get filled up quickly.
To understand gaps, one needs to understand the character of congestion areas within the market. A congestion area is simply a price range in which the market has traded for a few period of time, usually a number of weeks approximately.
A good confirmation for trading gaps is if they are associated with classic chart patterns.
For example, if an ascending triangle all of sudden has a breakout gap to the upside, this can be a much better trade than a breakaway gap without a good chart pattern associated with it.
Figure 4: Candlestick Streaming Chart Showing Breakaway Gap Trading Rules:
Upside Breakaway: If the gap is accompanied by heavy volume, go long and take a stop loss at the lower end of the gap.
Downside Breakaway: If the gap is accompanied by heavy volume go short and take a stop loss at the upper end of the gap.
3.2.3 Runaway Gaps
Runaway gaps also are called continuation gaps and are best described as gaps that are caused by increased interest in the stock.
For runaway gaps to the upside, it always represents traders who didn't get in during the initial move of the uptrend and while expecting a retracement in price, decided it had been not getting to happen. Increased buying interest happen all of a sudden and therefore the price gaps above the previous day’s close.
This is also called a measuring gab because it usually occurs at the middle of move and helps to measure the probable size of the trend. Runaway gaps can also happen in down trends.
Trading Rules: If volume is high, then Enter the trade early and await new highs to verify the pattern. If there are none in the next few days then exit immediately- it might be an exhaustion gap. (or new low during a down-trend)
ACCENT JOURNAL OF ECONOMICS ECOLOGY & ENGINEERING
Peer Reviewed and Refereed Journal, ISSN NO. 2456-1037Available Online: www.ajeee.co.in/index.php/AJEEE 3.2.4 Exhaustion Gaps
Exhaustion gaps are those who happen near the end of a decent up or down trend. They’re repeatedly the primary signal of the end of that move. They’re identified by high volume and huge price difference between the previous day’s close and also the new opening price.
They’ll easily be mistaken for runaway gaps if one doesn't notice the exceptional high volume.
The high volume was the giveaway that this was getting to be either an exhaustion gap or a runaway gap. Because of the dimensions of the gap and an almost doubling of volume, an exhaustion gap was within the making here.
Exhaustion gaps are quickly filled as prices reverse their trend. Likewise, if they happen during a bull move, some bullish euphoria overcomes trades, and buyers cannot get enough of that stock. the costs gap up with huge volume; then, there's great profit taking and the demand for the stock totally dries up. Prices drop, and a major change in trend occurs.
Exhaustion gaps are probably the easiest to trade and profit from.
Exhaustion Gaps Trading Rules:
Upward Exhaustion Gap: Sell short (or close your long position) and protect yourself with a stop above the last high.
Downward Exhaustion Gap: Go long (or close your short position) with a stop below the latest low point.
Figure 6: Candlestick Streaming Chart Showing Exhaustion Gap 3.2.5 Island Cluster
An island clusters reversal is a chart formation where there's a gap on each side of the candle after few days.
A key sign of a valid island reversal is a rise on volume on both the primary gap, then the next gap within the opposite direction. An island reversal formation is often attributed to news driven events that occur in there-market or after-hours trading.
Figure 7: A: Candlestick Streaming Chart Island Clusters Gap Showing Bullish then Bearish
Figure 8: B: Candlestick Streaming Chart Island Clusters Gap Showing Bearish then Bullish
4. EFFICIENT MARKET HYPOTHESIS
ACCENT JOURNAL OF ECONOMICS ECOLOGY & ENGINEERING
Peer Reviewed and Refereed Journal, ISSN NO. 2456-1037Available Online: www.ajeee.co.in/index.php/AJEEE 4.1 Version of EMH
1. Weak EMH
2. Semi Strong form EMH 3. Strong Form EMH 4.1.1 Weak Form EMH
This form stipulates that current asset prices reflect past price and volume information.
This form implies that investors should not be able to outperform the market.
Yet, many analyst study past stock price and volume data in an attempt to generate profits.
Contradicting: Technical Analysis 4.1.2 Semi Strong Form EMH
It states that all publicly available information are quickly incorporated in prices.
Publicly information means not only previous stock prices but other financial information of the companies.
It indicates good or bad financial information are of no help in forecasting future price movement.
Contradicting: News, announcement 4.1.3 Strong Form of EMH
It states that private and insider in formations incorporate very quickly.
Difficult for management and insider to reap abnormal gains having price sensitive information.
It indicates markets are totally unbiased.
Contradicting: Insider News or information’s 4.2 Conclusion On EMH
EMH is controversial and disputed among market experts.
EMH is theoretical
EMH even strong form of EMH is not fool proof.
Example of failure of EMH, many times cheap and inferior quality stock outperform.
5. DATA AND METHODOLOGY
The Indian stock markets are selected as an example of an efficient and inefficient market respectively. The chosen frequency is daily because gaps are most noticeable in daily charts (statistically significant price gaps are mostly found at this frequency). The sample period is April 2020− April 2021.
6. PROBLEM DOMAIN
It is observed that the maximum number of gaps are eventually filled, but it's not always the situations. However, we cannot explicitly ascertain a fixed time duration within which a gap gets filled. Thousands of gaps are created in several stocks with some of them never getting filled; hence, it might not be appropriate to base trading strategies purely on the idea that the gap will be filled in the immediate future. quite often, we also witness partial filling from the gaps before prices reverse and continue their original trend.
An example of a gap getting filled immediately can be seen in the chart below.
Figure 9: A: Nifty Bank Streaming Chart
In the above example of Nifty Bank, the downward gap got filled within three trading sessions. In the below example of a gap not getting filled for years can also be seen below.
Figure 10: B: Reliance Industries Ltd Streaming Chart
In the above chart, the bullish gap in Reliance Industries Ltd formed in April 2020 and has still not been filled. There is a good chance that this upward gap may not be filled for a few more years.
Another example of a gap not getting filled for years can also be seen below.
ACCENT JOURNAL OF ECONOMICS ECOLOGY & ENGINEERING
Peer Reviewed and Refereed Journal, ISSN NO. 2456-1037Available Online: www.ajeee.co.in/index.php/AJEEE
Figure 11: C: Cipla Ltd Streaming Chart
In the above chart, the bullish gap in Cipla Ltd formed in April 2020 and has still not been filled. There is a good chance that this upward gap may not be filled for a few more years.
7. PROPOSED SOLUTION
It is important to avoid giving weight age to gaps that do not carry much technical significance. While this may have some demerit for breakaway and exhaustion gaps. As high volume occurs in a breakaway gap and low volume occurs in exhaustion gap. . As there are always a large number of both buyers and sellers within the market, price movements always occur efficiently (i.e., during a timely, up-to-date manner). Thus, stocks are always trading at their current fair market price and holding positions expecting breakout or runaway gaps to be filled are often devastating the portfolio. The continuation gap and exhaustion gap are very different; therefore the trader has to make sure of the gap he's getting to follow. When gap-trading, Individual traders are often those to decide with the flow of the market, whereas institutional investors will ride the tide to see how it benefits their portfolio. it's important to avoid giving weight age to gaps that do not carry much technical significance.
8. CONCLUSION
In conclusion, Analyzing it thorough, Gaps do eventually fill but that could happen after a strong move or trend takes place and may take an extended time for the market to vary direction or gaps might not be filled in the future as shown in figure. Holding positions thanks to gap up or gap down and expecting while to be filled are often devastating the portfolio. Also according to EMH, the basic efficient market hypothesis asserts that the market can't be beaten because it incorporates all important determining information into current share prices. Therefore, stocks trade at the fairest value, meaning that they cannot be purchased undervalued or sold overvalued. According to study on gaps theory with reference to EMH and analysis of some stock, it's important to avoid giving weight age to gaps that don't carry much technical significance.
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