What Is Trading The Gap

Trading the Gap

The price gap is a region on a chart where no trading activity takes place. These gaps can be identified when using bar or candlestick charts. Gaps will usually open above or below the price it closed at. Trying to take advantage of this difference between prices is know as trading the gap.

What are the Gaps?

Price gaps appear because of various fundamental or technical factors. For example, if a company’s profits are skyrocketing, the company’s stock may produce trading gaps the next day. In other words, the stock price opened higher than the closing price, thereby producing a price gap.

In the forex market, it is not common for a significant price gap to appear, as there isn’t one factor that operates the market. The forex market depends on a lot of factors and many market participants. That’s why bigger price gaps don’t often emerge in the forex market. They do however commonly occur over the weekend when the market is closed.

Gaps can be categorized into four groups:

  1. Breakaway gapsemerge at the end of a price pattern and signal the formation of a new trend.
  2. Exhaustion gapsform near the end of a price pattern and signal price’s attempt to create new highs or lows.
  3. Common gapsdon’t establish in a price patternThey represent an area where the price has gapped.
  4. Continuation gaps, also known as the runaway gaps,develop in the middle of a price pattern and signal a hurry of buyers or sellers who wants to enter the trade based on future predictions.

When a price gap fills, it means that the price moved back to the pre-gap level. These fills are very common and appear due to the following reasons:

a. Disturbance

The initial spike may have been overly optimistic or pessimistic, therefore forming a correction.

b. Price movements

When a price moves up or down sharply, it doesn’t conclude any support or resistance levels.

c. Price patterns

Price patterns classify gaps and can tell if a gap will be filled or not. Exhaustion gaps are most likely to be filled because they signal the end of a price trend, while continuation and breakaway gaps are less likely to be filled since they are used to ratify the direction of the current trend.

Here’s how the gaps appear on the chart:

Trading the Gap on a chart
Trading the Gap on a chart

How to play the Gaps?

Playing the Gaps is the terminology used for trading the Gaps. To play, traders need to consider the following points:

  1. It’s important to know which of the four types of the gap a trader has identified. A continuation gap prolongs a trend while an exhaustion gap reverses it. So, it’s up to traders to decide which gap they want to trade.
  2. When a price gap starts to fill, it does not always stop. Hence, it doesn’t give any support and resistance levels.
  3. Breakaway gaps typically show high volume, while exhaustion gaps represent lower volume.

Apart from these rules, a trader should remember a few more points when playing the gaps in the forex market.

  1. The trade may be in the overall direction of the price depending on the traders individual strategy. The price of the pair would usually need to gap significantly above or below a key resistance level on the charts.
  2. The price could retrace to the original resistance level. This indicates filling of the gaps, and the price returning to the previous resistance.
  3. There could be a candlestick pattern that displays the continuation of the trend in the direction of the gap.
  4. As the forex market operates round the clock (open 24 hours a day from 5:00 pm EST on Sunday until 4:00 pm EST Friday), gaps in the forex market can emerge over the weekend.

Trading the Gap Conclusion

Gap trading can risky due to low liquidity and high volatility, but if properly traded, they may offer opportunities for good trades.