Do Opening Gaps Tend to Fill?

The difference between the market's opening price and its previous day's close forms a gap on a bar chart. Does this gap tend to fill in during the next day's price action? That is, when we open with a gap lower or higher, do prices subsequently move back to the prior day's close?

For this investigation, I measured gaps as a function of the previous day's high-low range. This measures the gap relative to the prior day's volatility. Thus, an opening gap of two points that follows a day with a range of six points is measured as a 33% gap. The same opening gap of two points that follows a day with a range of ten points is measured as a 20% gap.

Assessed in this manner, we find that the average opening gap is 27% of the previous day's range going back to May, 2003 (N = 897 trading days) in the S&P 500 Index (SPY). That provides us with a benchmark for defining relatively large and relatively small gaps.

When upside gaps exceed 40% of the prior day's range (N = 99), 46 of them fail to close during the day session. When downside gaps exceed 40% of the previous day's range (N = 81), 40 of them go unfilled. Bottom line: approximately half of all large opening gaps don't fill during that coming day's action.

Conversely, when the upside or downside gaps are less than 40% of the last day's range (N = 717), only 144 of them go unfilled. When the gaps are less than 20% of the last day's range (N = 431), only 51 of these fill in. Stated otherwise, 80-90% of relatively small gaps will fill in during the coming day's action.

Interestingly, when we have a large opening gap to the upside, the *following* day's price change averages .18% (68 up, 31 down). When we have a large opening gap to the downside, the next day's price change averages .09% (48 up, 33 down). But when the opening gap is small, the subsequent day's price change averages only .03% (381 up, 336 down). In sum, large gaps in either direction tend to be bullish for the next day's price change.

When we measure gaps in this fashion, it takes relative changes in volatility out of the equation. The average size of the opening gap, defined as a function of the prior day's range, has been the same in 2006 as previously, despite our dramatic drop in volatility since 2003. Standardizing how we measure gaps provides us with a better sense for when gaps are large--and are less likely to fill--and when they're small--and more likely to fill.

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