Gap Support and Resistance (S&R) levels form due to price gaps on a chart, typically occurring overnight but sometimes during a trading session.
(Fig 1.1 - Gap S&R )
Overnight gaps, especially large ones, serve as powerful S&R levels for approaching prices, even days later. The larger the gap, the stronger the S&R. Small gaps or those within a range can be ignored. Focus on large gaps that signify a breakout or breakdown from a pattern or a range, as they are particularly significant.
Once a gap forms, closely monitor price action as it approaches the gap within the next 1-5 days. Typically, prices penetrate the gap, encounter support or resistance, and reverse. A reversal pattern after penetration confirms a strong trade. However, if a candle fills a large gap and closes strong without reversing, it signals that the Gap S&R has been overcome, indicating a continuation in the same direction.
EXAMPLES
In the Crude 2-hour (2H) chart, the third oval highlight marks a significant overnight gap down. On the same day, the price makes a feeble attempt to test the gap but reverses sharply once a Bearish Engulfing candle forms later in the day. On the third day, the price action rises to fill the gap. However, the 2H candle fails to close above the gap, and a Bearish Engulfing reversal forms on the next candle.
Notably, there is also a Horizontal Resistance at the point where the reversal pattern forms. This confluence of Gap and Horizontal Resistance adds to the strength of the reversal. The sharp price decline that follows underscores the significance of this setup.
(Fig 1.2 - Gap S&R on Crude Futures)
The second example is from a Zinc 2H chart. The first and the third oval shapes represent overnight gaps ups which subsequently offer strong support to price action approaching from above.
(Fig 1.3 - Gap S&R on Zinc Futures)
In the next example from the 1H chart of Nifty Futures, we observe typical overnight gaps. There are 2 gaps in this example which are significantly large (exceeding 0.5%, approximately 110 points when Nifty is around 22000). Whenever you have such gaps, it is time for you to sit up and take notice.
First Gap: January 17, 2024
On January 17th, Nifty experienced a substantial 280-point gap down. After a steep decline over the first two days, Nifty revisited the gap on Days 4 and 5. The gap acted as strong resistance, causing the price to drop back into a significant decline on Day 5.
Second Gap: January 29, 2024
On January 29th, Nifty saw a 240-point gap up. Following a strong rally on Day 1, the price retraced to test the gap on Day 3. As expected, this large gap provided robust support, reversing the price into another strong rally.
(Fig 1.4 - Gap S&R on Nifty Futures)
On the Nifty Futures 1-hour (1H) chart, there is a modest 70-point gap up on May 3, 2024. However, the gap is filled by the second candle of the day, which closes strongly below the gap. This indicates that the gap support was breached, setting up a strong downward move.
(Fig 1.5 - Gap S&R on Nifty Futures)
With this, we have covered all four different types of S&R. Please click on "Next Post" to watch a video on all four types of S&R.
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