The gap is usually seen on Monday, with the start of the Pacific trading session.
And the price can suddenly drop several points.
On Friday, when the American trading session closed, the price was the same. On Monday, with the opening of the Pacific trading session, it is completely different. And the price difference is called the gap.
The gap can be 5 points, or even all 40-70. And the price, in turn, can go up and down.
What are the reasons?
And the reasons are prosaic. Any currency depends on the political events that take place in the world.
For example, political statements by leaders of developed economic countries such as Japan, Great Britain or the United States.
If Boris Johnson or Joe Biden declare that in the next few days their states intend to enter a war, the market will not pass without a trace.
Another reason for the lag is the declarations of the heads of the central banks, which are also made on weekends when the stock markets are closed.
Well, the third is unforeseen circumstances: natural disasters, man-made disasters, etc.
The most common reason is a drop or rise in stock or trading in the absence of new contracts.
For example, the profit of the company significantly exceeds the forecast figures. This guarantees an increase in price the next day.
What strategy is suitable to apply in such a situation? All answers will be provided below.
Types of gaps
In total, the spaces can be divided into 4 groups:
“normal space”. Here the gap is because high liquidity has become priceless;
- “for the tests”. Such a gap indicates the start of a new trend. And it is approved at the end of the formation of the price model;
- The so-called “fatigue gap”. Occurs at the end of a move and signals the last opportunity to set a new low or high price;
- An extension gap confirms the strength of a trend and appears in the middle of a price movement. This gap clearly demonstrates the desire of the bulls or bears to maintain the trend in the market.
- Gaps appear at least once a week on almost all trading instruments.
If there is a price gap, the price will most likely try to fill it and return to the point of formation of this gap.
In principle, this is logical. The laws of the economy in this respect are similar to the laws of nature: like nature, the economy tends to return to a harmonious balance.
Price gaps can be filled in the following cases:
– Due to the bright reaction of bulls and bears, a clear vector appears. And then inevitably comes a correction;
– Reasons of a technical nature, which are difficult to track on the chart;
– The fatigue gap will inevitably fill, because it is a bright marker of a trend reversal. And soon the price will definitely return to its previous values. The main thing is not to confuse it with the extension gene. Otherwise, the trade will be closed to the detriment of the trader and the stop loss.
When the gap fills up during the day, it is customary in trader parlance to call it a “fade out.”
For clarity, let’s take an example: the company announces an increase in earnings for the quarter.
On this basis, a “boom” arises and traders begin to massively buy stocks that are rising in price.
And then it turns out that the forecast was too optimistic: yes, there was an increase, but now the concern has no new products, and subsequent growth will not follow.
After that, the traders who bought shares wholesale start putting them up for sale. And the price naturally returns to the preliminary level.
A trader should try to take advantage of this state of affairs. After all, a gap is a great opportunity to increase your income from him.
What strategies are used in gap trading?
An experienced trader uses many ways to trade gaps effectively. We list the most common:
1. By acting on the stock exchanges, traders open orders. They do so on the condition that during the next trading day they see the possibility of a price gap between the value of the assets.
This is usually done after the publication of an optimistic forecast on the company’s earnings. And traders know that this will inevitably lead to a price gap.
2. The second strategy is to sell. This is done with the expectation of filling the void.
It is worth remembering that sometimes traders deliberately “extinguish” the gap and, after a gap in a significantly higher price, open deals to sell.
This is where crowd psychology comes into play. After all, once the space is filled, you can buy right away. Due to this, the price receives a significant level of support.
What should you never forget when trading gaps?
1. If you see that the space is filling up, make sure that this process will continue.
2. Before entering the market, carefully check what signals the gap refers to: these are extension signals or, conversely, a trend reversal;
3. Check the trading volume regularly. If the trade is on a large scale, then you can safely take risks. If trading is carried out in small volumes, then there is a fatigue gap, which makes no sense to join;
4. Remember: due to gaps, traders start massive rash actions and make dubious transactions. The big funds are trying to protect their assets. To this end, they fill the void in Forex.
5. It is important to follow one important rule: do not trade a minute or several minutes before or after the release of economic news.
6. To protect yourself from possible losses, it is enough to close open orders for the weekend. In addition, you can also increase the stop loss and control the start of trades on Monday.
How to use the strategy correctly
1. Trade only with the trend. This rule applies to both gap trading and Forex trading in general. It is better to determine trends over long periods of time and use hourly charts
. 2. Look at the price gap: it must be big. The ideal option is when prices are above the resistance level or well below the support level. It is desirable that the size of the gap be at least 30 points.
3. Please note: quotes will have to pull back to the resistance level that was noted earlier. It will now act as a support.
4. Before entering the market, wait for confirmation. Confirmation will be the close of the next candle after the one that revealed the formation of a price gap.
Then it will already be possible to confidently join the existing movement and understand that a strong momentum lies at the base.
What else should be remembered?
An experienced trader can anticipate the formation of a Forex gap and classify it correctly. However, the gains can be huge.
But always remember that when traders try to capitalize on a gap, they are closely watching patterns.
And to reduce risks, it is desirable to have access to an ECN network in real time. This is how trading volume is estimated. And you will see for yourself how many orders the price will have to pass before the gap is filled.
If the number of orders goes off the scale, then the trader should not enter the market.