What are gaps on the Forex market?
Any situation a trader faces should be either taken advantage of or avoided. In the case of gaps, you need to be careful. In this article, we will learn what gaps are, why they appear and how they impact your trading.
A gap is a price break in the chart of a trading instrument. In other words, if the closing price of the previous time interval differs from the opening price of the subsequent interval, we see gaps that look like voids in the chart. Gaps can be seen in candlestick and bar charts because they represent the open and close prices of each timeframe.
It is important to keep in mind that brokers, contrary to popular belief, are not involved in the emergence of gaps on the financial market.
When and why do gaps occur?
There are several main reasons for gaps. Various economic and political events take place on the weekend and the market reacts to them. As a result of these events, when you open a new trading session, you can see a price gap in the chart of a trading instrument, as in the following example.
A gap can also occur in the middle of the week in case of unplanned events. Important decisions of large players on the currency market, such as bankruptcy, merger of large companies, or political instability in the country, can cause strong unrest among traders and resulting price jumps.
Major criminal incidents and man-made disasters can also affect the economy. The market, in turn, reacts very sharply to such incidents with random gaps.
How to trade using gaps?
When using gaps in a trading strategy, it is important to understand the reason for their occurrence. Random gaps in the middle of the week are quite rare and are not a signal for further direction of price movement. In such situations, price jumps can occur in both directions, and beginners are not recommended to trade in these conditions.
At the same time, many experienced traders use gaps that formed after the weekend to make a profit. This strategy is based on the fact that about 70% of such gaps get closed, i.e. after the exit gap, a price reversal occurs. This happens because traders profiting from the breakout close their trades to take profit. Small gaps are quickly compensated. Traders open trades in the direction of the gap closing.
Unfortunately, this does not always happen. Sometimes the gap does not close and the price moves on. Such cases may indicate a longer market movement and the beginning of a downtrend or uptrend. There are times when the price closes the gap only months or even years later.
If you nevertheless decide to open positions, hoping for a price reversal, remember to set up stop orders.
Our example shows trading with a gap. In such a situation, it is not recommended to set the Stop Loss level at a short distance, since the price may retain its initial movement for some time by inertia and quickly reach S/L. Take Profit should be placed at the close price of the previous interval. Keep in mind that the gap will not necessarily be completely closed, so it is better to control such a strategy manually in order to have time to close the buy order in the event of another market reversal.
How to avoid losses due to gaps?
It is important to understand that Friday's gap can bring both profits and losses.
If the gap has occurred in the right direction, the trader can close open positions with a profit. Based on the market situation, a trader can earn even more with a price reversal by opening new positions in the direction of the reversal.
What if the gap turns out to be unprofitable? To save your deposit, you should stick to some basic rules:
If you are an inexperienced trader, the less trades you leave open for the weekend, the better. With a negative gap, a trader with many opened positions may face a shortage of funds up to a Stop Out.
Keep in mind that Stop Loss will not save you if the gap jumps over it. Suppose you have a buy position opened on Friday. The Stop Loss level is set at the price of 1.79850. The market closes at 1.79865 and opens with a gap at 1.79835 on Monday. Stop Loss will be triggered at the first market opening price of 1.79835, not at the level of 1.79850. Accordingly, your loss will not be the planned 15 points, but 30 points.
Do not expect an instant price reversal. Usually, after the start of the trading session, it moves in the direction of the gap for some time, further increasing the floating loss.
Not every gap will close too. Sometimes a gap is just the beginning of a long trend. In order to understand what kind of situation you are dealing with, you need to correctly use the fundamental analysis of the market, be able to identify the patterns of price movement, and also understand support and resistance levels.
For some traders, gaps can be an additional opportunity to make money. For others - the reason they lost their deposit. Just remember that trading with gaps and hoping for their reversal is associated with high risks. Experienced players only earn on gaps with proper money management and stop orders.
Article last updated: 2022-10-28