Gaps in general are created by price jumps between periods. Something has created a sudden surge in demand or supply, and one period opened significantly higher or lower than the preceding period closed. Depending on which event created the price jump, a gap can have vastly different implications.
Runaway gaps indicate an accelerating trend. Typically, runaway gaps in the upper region of an uptrend or the lower region of a downtrend. The market was already advancing further in the trend’s main direction and still created a gap in trend direction. This is a sure sign that, for a majority of the traders, the market was still moving too slow. They saw the market advancing to new extremes and still wanted to invest. This is a strong sign the market will accelerate its movement in the trend’s main direction.
As a trader you need to be able to distinguish a runaway gap from a breakaway gap, which indicates the creation of a new trend, and an exhaustion gap, which indicates the end of the current trend. If you mistake one gap type for another you are almost certain to lose your investment.
By definition, runaway gaps occur when the market is trading in the upper / lower trading range of a trend. In an uptrend, the market should be trading in the upper area of the trend. In a downtrend, the market should be trading in the lower regions of the trend.
To make finding these areas easier and more reliable, you can use a technical indicator. Many traders use oscillators such as the Money Flow Index. When these oscillators are in oversold / overbought areas, you can be almost certain that the market is currently moving in the right trading range for a runaway gap. This method for finding the market environment is especially helpful if you plan to automate your trading strategy or your signal creation process.
Any movement becomes more significant when it is accompanied by high volume. This rule applies to runaway gaps, too. Since a runaway gap is supposed to indicate a significant change in market sentiment, you have to be sure that many traders share the sentiment indicated by the gap in front of you.
A gap that is accompanied by high volume is a sure indication of a significant change in market sentiment that can accelerate the market for a long time.
One very successful strategy to find breakaway gaps is to monitor the market for sudden surges in volume. Often, the surges are accompanied by a gap. If that gap occurs during a trend near the top of the trading range, you have a good chance it is a runaway gap.
There are a number of ways to trade runaway gaps:
One way of trading runaway gaps is by using touch options. Runaway gaps indicate the beginning of an even stronger movement than the current trend. That is a huge advantage. Since your broker calculates its payout based on the current market environment, it does not factor in the implications made by the breakaway gap.
You, however, know that the market environment will change soon: The market will pick up momentum. Therefore, you are one step of your broker, which tips the risk / reward ratio in your favor. Therefore, as soon as you identify a runaway gap, this is the perfect time to invest in a touch option, predicting a strong price movement in the direction of the gap.
Since touch options feature high payouts of up to 300 to 500 percent, you do not win a lot of these trades to make a profit. If you can find good settings for your indicators, you should easily be able to run this strategy profitably.
If you do not like touch options, the more conventional approach would be to invest in a high / low option in direction of the runaway gap once the gap occurs. Of course, high / low options offer lower payouts than touch options. You should, however, be able to win a higher percentage of your trades with high low options, which can make up for the lower payout.
Make sure to keep the expiration time of your high / low options short to medium compared to the time frame you are trading. If you are trading a 5 minute time frame, for example, you should not use a one hour expiration time. Stay with a 15-minute expiration time, and you should be able to win a high percentage of your trades.