Opening price definition
What is the opening price?
The first transaction of the day is executed with the opening price. Other transactions executed during the day may be completed at a higher or lower price. Though logically you would expect the closing price from the previous trading day to be the opening price for the next trading day, there are some fundamental factors which can influence the opening price. These factors include announcements for higher or lower than expected earnings, announcements of other company-related news, after-hours trading, investors’ expectations, etc. It is worth mentioning that each of the factors could have a positive or negative impact on the price, i.e., the opening price could increase or decrease.
Let’s say that the closing price for a stock is $20. Before the beginning of the next trading day, there is an announcement that the company has developed a new product which will increase company profits in the future. Investors will value the company more because they will anticipate higher earnings. Hence, the opening price on the first trading day after the announcement increases to 22$ (or $2 higher than the last closing price).
On the other hand, let’s say there has been a situation in which the company has been associated with some scandal, for instance, a scandal with fraudulent activities or misreporting of earnings. In this case, investors will assign a lower value to the company because the company will have lower earnings. Since the investors now value the company less than the previous day, the opening price on the next trading day decreases to $17.
Opening price gap explained
The difference of $2 and $3 between the closing price and the opening price in the examples is referred to as a “gap.” In the first example, it could be said that there was a “gap up” since the opening price is higher than the closing price. In the second example, the gap is referred to as “gap down” because the opening price is lower than the closing price from the previous trading day. Investors use the opening price to create a trading strategy. The opening price trading strategy is centered around the gap up or gap down for a given stock.