What Are Price Gaps in Forex Trading
The phenomenon known as a price gap in forex trading is actually a pretty simple concept. The price gap is the empty area, hence the name, that occurs when the opening price of a candlestick is not the same as the close price of the previous candlestick. Despite not that common as in stock trading, gaps do happen in the forex market too, mainly because of the fact that the forex market is closed for retail traders during the weekend but it is still active for operations by the International Bank. In this article, you will be able to find out more about price gaps in forex trading and why many forex traders see gaps as yet another great opportunity for trading and potentially making a profit.
The gap basics in forex trading
Gaps are a part of the experience of every forex trader. They occur in the foreign exchange market as the empty areas between the close of trade and the open of another.
Despite the fact that gaps are more common for the stock market, they still occur in the forex market but less often.
The main reason for price gaps in forex trading to exist is the fact that the forex market itself operates 24/5 and not during the weekend, however, the Interbank market is active 24/7. Furthermore, price gaps are expected to happen between the close price of a pair on Friday and its open price on Sunday.
As the price is moving up or down during this period, the chart shows this change in the normal price pattern as a price gap in forex trading. Price gaps in forex trading can also occur in as short timeframes as a minute or less, especially when following a major news announcement, usually global and unexpected news.
The main reason for price gaps to occur is the underlying fundamental and technical factors that have an impact on the forex market. It is not uncommon for a report to attract a lot of interest and cause a higher activity and by this, it widens the bid and the ask spread to an extent that it leaves a gap between both.
So why do you want to know about price gaps in forex trading if you are a forex trader? First of all, the path to success in forex trading is definitely easier to walk when you understand the whole concept and mechanism of forex and pay attention to details.
We at Trading Education understand the importance of a sustainable and lasting set of fundamental knowledge about forex trading and this is the main goal of the forex course we are providing you with.
Price gaps can give a better idea of the forex market sentiment. As an example, gapping up often means that traders are not willing to sell at the levels of the gap while gapping down shows no intentions for buying at the levels of the gap. Price gaps can be used as additional guidance when trading with forex.
Second of all, this tiny empty area between prices that represent their fluctuation can be potentially exploited by the forex trader for making a profit which is better known as trading with gaps.
Gap trading is considered to be easy, reliable, and profitable by some forex traders or very risky and causing slippage by others and we are about to discuss more below so keep reading!
Classification of price gaps in forex trading
There are four groups of price gaps in forex trading as it follows:
- The Breakaway Gap – This one occurs at the end of a price pattern when a new trend starts. It means that the price usually breaks out of its more stable to an extent phase and starts moving up or down by this leaving a gap. This movement of the price is triggered by the release of breaking news or events hence the name. All the process forms a new trend and is considered as not tradable. An example of breakaway gaps in the pairs of EUR/GBP and GBP/USD are the gaps formed after the UK General Election in 2017. Read more about the example here.
- The Runaway Gap – Runaway gaps commonly form within a trend and they mark the fact that a trend is continuing. Runaway gaps are considered tradable and also one of the safest ways to trade with gaps in general because runaway gaps are traded when the trader already knows the possible continuation in the trend direction. You can combine trading with runaway gaps with other price action tools for an even higher safety of the trades.
- The Exhaustion Gap – Despite the fact that exhaustion gaps are common for the stock markets, they also occur in forex, however, significantly less often. These gaps are formed towards the end of a previous trend and indicate the final moment before the prices start to reverse or lose it. This pretty much means that you can trade with exhaustion gaps only after you identify them and you start trading with a new trend.
- The Common Gap – If you want to play with price gaps in forex trading, the common gap is the best way to start as it is the most widely traded one of the four categories. In addition, the common gap is considered the safest one to trade. These gaps usually appear during late Sunday and early Monday opens and usually appropriate for short-term trading as they tend to be filled within several price bars. The best time for looking for common gaps is around midnight market opens. Common gaps can also occur after a holiday or when major news and events have been announced.
What does it mean when the price fills the gap?
Filling the price gap pretty much means that the price moves back to its initial level before the occurrence of the gap. The price always fills the gap but it is most important to consider how long does it take for the price to fill the gap. When the gap is filled within the same trading day it occurs, this is called fading, but it does not happen all the time with gaps. It is also important to keep in mind how many pips will be used for the price to be back to its initial position. With that being said, filling the price gaps in forex trading is not necessarily feasible. However, the fact that the price always fills the gap is the reason why so many forex traders are interested in gap trading. It is definitely not rocket science to guess that if the price opens with the gap down and the price continues with going up in order to fill the gap and you trade gaps in the right moment, you will be able to make a profit. However, it not necessarily works that way and playing with price gaps in forex trading is affected by many factors that can define whether or not you will be able to make a successful deal.
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Trading with gaps – what you need to know about different tactics
Of course, some forex traders prefer to take advantage of the price gaps in forex trading and actually trade with gaps. However, gap trading can also be sometimes risky and not necessarily give you the results you expect. Still, some gap trading deals are successful and profitable. It depends on a number of factors you would like to take into consideration.
- One of the most popular strategies for taking advantage of price gaps in forex trading is buying when the technical and fundamental factors are in a favour of a gap on the next trading day. By this method, forex traders are hoping that the gap will go up on the next trading day after the release of reports or the announcements of important news.
- Some forex traders prefer to buy or sell at the beginning of a price movement into a highly liquid or illiquid position. By this method, forex traders are hoping to make a profit thanks to a good fill of the gap and a continued trend.
- As already explained, fading up the gaps is their fill in the same day of their occurrence. Some forex traders rely on the fading tactic by fading the gaps in the opposite direction once a high or a low point is determined. In order to do so, forex traders are usually using technical analysis to determine the movement of the price gap and the price.
- Finally, some forex traders prefer to buy when the price reaches its original level after the gap has been filled.
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How to minimise the risk?
A high probability of success and profit is often a matter of a good educational background. Forex traders who understand how the fundamental factors affect the occurrence of price gaps in forex trading and who know how to determine precisely the type of price gaps are usually experiencing more profitable trades and less loss. In this case, a reliable and up-to-date educational course of fundamental analysis in forex trading like this one offered by Trading Education can make a difference. Make sure to register on the website and you can get the full forex trading course for absolutely free!
However, even with the best forex trading education and the most detailed understanding of price gaps in forex trading, every forex trade has the potential to go bad for a number of reasons, even the trades that look highly profitable and safe at a first glance. Trading with gaps can be as risky as any other trade in the forex market. In order to minimise the risk you can make sure to do some or all of the following:
- Always watch and keep up with the real-time electronic communication network also known as ECN and volume. By doing this you will have a basic idea of where different open trades stand. A high-volume resistance that prevents the price gap from being filled is another possibility you want to take into account and reconsider trading.
- Be sure to wait for declining and negative volume before you take a position. In some cases, corrections are not immediately done by the market.
- Always use a stop-loss when trading with forex, don’t forget to do so when trading with price gaps. Experienced traders recommend to place the stop-loss point below key support levels, or at a set percentage. If you want to learn more about stop-loss make sure to check out this article by Investopedia here.
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So the big question now is whether or not you should trade gaps?
Of course, there is not a straightforward answer to this question because, as you probably know by now, nothing is certain when it comes to forex trading and each move you make on the market is determined by a lot of factors and aspects of forex trading.
The same rules apply for trading price gaps in forex trading. So to a certain extent trading with gaps in forex trading is not recommended if you rely only on the rumours and what others say about the gaps.
Keep in mind that every trader has a different style of trading, different interests in the market, different levels of risk tolerance, etc. In addition, you cannot believe in every word and option of someone, even if they are a forex trader you look up to.
It is highly recommended to first learn at least the basics of fundamental and technical analysis and use both methods for determining the factors that can have an impact on price gaps in forex trading and the forex market in general.
However, once you have a good basis of knowledge and you are able to stop a potentially successful gap trading opportunity, it does not mean that you have to miss the opportunity only because price gap trading is considered risky.
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