There is lots of buzz about different trading strategies that can be used on Forex trading. Traders are always trying to discover ways to leverage their chances of gains and strategize against the market. One popular strategy in Forex trading is what is known as the Gap Strategy or trading the gap.
So naturally, you may be curious as to what exactly is a gap in the trading world? Well the gap occurs when price action closes at one price level but opens at a different price level with no price action trading in between the close and open levels. It’s easier to visualize this if you can imagine the gapping occurring on a candlestick chart as opposed to a line or bar chart. Gapping is most often found in Forex on Sunday. When the market closes on Friday and re-opens on Sunday more likely than not there will be a gap as to where the pair trading price closed on Friday as opposed to where it opened on Sunday.
But gapping can and will occur at any time not just on Sundays. For this reason I will recommend that as a Forex trader, actively trading is and should be a part of your trading strategy.
There are four commonly known gaps
- Breakaway Gaps--usually happens when the trend reverses
- Exhaustion Gaps—occurs when price is at the high or the low for that timeframe and has one last attempt hit a new high or low.
- Common Gaps—is referred to when there is not an explanation that the trader can verify that would have cause price to jump
- Continuation Gaps—happens when trading volume is so rapid that by the time the orders are filled price jumps from the current price to catch up with the new trading price
You may hear terms like……
Gap Fill, which is when price action trades back at the pre-gap price.
Fading, which refers to the gap being, filled in the same day…..so in essence that gap faded away.
BASIC GAP STRATEGY KEY POINTS
There are numerous trading strategies that utilize the Gap to capitalize on profits. I will explain the basics of the Gap strategy. I do this because profitable traders know that a good strategy incorporates their own trading style in conjunction the guidelines of a basic trading strategy.
- Take note of price action at the market close----was the sentiment bullish or bearish? Do you speculate that price will continue or reverse?
- Know your fundamentals…..As previously stated price will close at one level on Friday and open at a completely different level on Sunday. For example, if a major event happened over the weekend and you speculate the event will cause your pair to rise or fall you can take the position when the market opens that coincide with how you predict the market will fill the gap.
- Know where to place exits—once you have determined the sentiment before the gap, if there were any significant events that occurred over the weekend that would drastically affect price, and then have taken (or determined) an entry position. Its time to plan your exits. Place your stop loss and your take profits at appropriate levels based on your trading style: aggressive or conservative.
- Take note and actively trade. Once the market is in full swing make sure you journal your trade in detail. Mention the fact that you are trading the according to your gap strategy.
Tips for Trading the GAP…..
To increase your odds of successfully trading the gap the Forex Trader needs to keep in mind:
- Gaps are not guaranteed to fill
- Gaps may not fill immediately
- Test your strategy with your demo account first
- Back test your pairs to learn the typical behavior of the pair after the gap happens
- Record, document, review your Gap strategy, make adjustments and follow through.