Gap Theory for Stocks

Stocks open at the same level at which they closed in previous session. When they open well above the previous session's close or below the previous session's close, they form a 'GAP' in the chart. The Japanese in their picturesque terminology, called these windows. While an analyst would welcome gaps in the charts, positional traders would be happy to issue a ban on gaps, if they could. They play havoc with positions that are rolled over.
What can an intra-day trader do if the market opens with a gap in the morning? Hewould need to take into account the prevalent trend in the morning before acting on a gap. If the market is in a strong uptrend, it can stabilise at the higher level after a gap 'up' opening and then move up further in the later half of the session. So the trader would wait for the prices to sustain at higher levels for at least an hour and then play long with a stop just below the level where the gap began.
Similarly, in a market that is trending down, downward gaps would be common. If the price moves sideways after a downward gap, there is a high degree of probability that the price would fall further as the trading day advances and hence provides an oppurtunity to go short for the intra-day trader.
It is of course, of paramount importance to determine if the gap is a strong one that will go unchallenged for many days or a weak one that will get filled the same day. The magnitude of the gap would play a critical role in deciding its strength. As a rule of thumb , smaller gaps are more likely to get filled the same day when compared with a largae gap.
The way to determine if the gap is small or large would be to compare with the previous day's trading range. Gaps that are more than 50 percent of the previous day's trading range are more likely to remain open for awhile when compared to gaps that are less than 50 percent of the previous day's trading range.