This is the third in a 5-part series of blog articles, all about gaps and what they mean.
Some traders think gaps are anomalies and should just be ignored. But in fact, gaps often provide excellent signals or act as part of other signals. Some gaps can be ignored, others cannot. The key is knowing the difference.
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Proximity for reversal
When gaps occur at the point of resistance or support and take price through those important price borders, they provide strong indication of coming reversal. The longer a trading range has lasted, the more difficult it is for price to break through. When that is seen with a gap, reversal is most likely. This gives you an excellent timing observation for entering a short-term swing trade.
An example of failed breakout
For example, on the chart of Amazon.com (AMZN), support was indicated at $1,480 per share from mid-February through the end of April. At the end of March, price gapped more than 50 points down, taking price more than 40 points under support.
This is precisely the type of pattern where you would expect to see price reverse and move back into range. It took a full month, but that is exactly what occurred. A second pattern that occurs frequently is a strong move in the opposite direction after the failed gap. Once price returned above the support level, it gapped 50 points higher at the end of April, potentially setting up a successful breakout to the upside.
This analysis is typically what you see with gaps at the point of breakout.