What Is Gap Analysis in Finance?

When the management and board of directors of a company see a substantial gap between performance and expectations, changes need to be made in operations or in management. Competent gap analysis will commonly make clear which path to follow.

Value investors commonly look at intrinsic stock value. When there is a gap between company potential and current performance and when that difference is likely to be remedied with time, a value investor will buy with the expectation of long term profits.

Equity Gap Analysis

What is the meaning of gap analysis for you as a short term investor or trader? You will often seek to profit from daily jumps (up or down) in the price of a stock. A correct interpretation of just why a stock price jumped leads to profits while an incorrect interpretation can lead to dismal results.

Advantages of Gap Analysis

Gaps occur most often because of either technical factors or quick changes in fundamentals. To take advantage of gap analysis, you need to know your gaps.

Breakaway Gaps

These happen when a trend has run its course and the market will move in the opposite direction.

Exhaustion Gaps

This is what happens when a trend or price pattern has largely run its course and not everyone sees it. As such, there will be a last heroic shot at a market high or desperate drop to a low.

Continuation Gaps

These are also referred to as runaway gaps. They happen in an established trend and typically signal that more investors are getting bullish (or bearish).

Common Gaps

This is the catch-all term for when a gap occurs and the reason is not clear.
And, you need to learn how to predict whether a gap signals a movement onward or will “fill” or move back to the original point. We wrote recently about the Tesla short squeeze. This was an instance when the gap refilled as the effects of the short squeeze evaporated.

Gap Analysis Model

In order to deal effectively with gaps between performance and expectations, a company needs a process. Luckily, a gap analysis model does not need to be developed from scratch. Many are available as are experts in revitalizing businesses. Likewise, a trader or investor who wants to profit from gap analysis needs to follow a reliable model. These are also readily available. The key is to learn the model and how to use it!

Gap Analysis Methods

When investing in stocks, you can use both fundamental analysis and technical analysis methods in gap analysis. Although the eventual price of an equity is determined by fundamentals, the daily variations, including gaps, are caused by market sentiment which is amenable to analysis with technical tools.

Gap Analysis Chart Templates

The best way to learn and apply gap analysis is to use templates which demonstrate the various types of gaps and how the market will act after the gap happens. This example demonstrates a runaway gap.

Gap Analysis Protocol

Successful traders and investors pick and choose the equities and market sectors in which they trade or invest. The same will apply to gap analysis. Many times a value investor will be watching a stock in hopes of buying at an attractive price. He or she may even be able to predict when a gap will occur. The most successful already have a gap analysis protocol in place that allows them to carry out fast and effective analysis that results in profits.