So it’s technical Tuesday so we will be going over one of our favorite trading strategies that we go in depth with in our trading course. Gap trading is one of my favorite trading strategies in Forex trading and I often get asked by my community how to put together a strategy to trade it efficiently. Forex market gaps are real easy to spot as it’s literally a physical gap in price from close to open.
First, let me tell you what a gap is and why they appear on the charts.
A Gap is an empty space you can see between two bars on any price chart. It appears because of the price movement during the time that the chart had not been updated, like when the market is closed. “Gaps” are very common in the stock market as the stock market is not open 24 hours per day like the forex market is, and for example the New York Stock Exchange (NYSE) opens at 9:30 a.m. and closes at 4:00 p.m.
In contrast now, the Forex market is however open a full 24 hours per day and 5 days per week. We don’t often see Forex gap’s as they have only been around with the introduction of the non-dealing desk brokers. We can rarely see a gap during the week unless a major news event releases and there is a flood of orders gaping the chart.
However, when the market’s are closed on the weekend, we can sometimes get gaps maybe once or twice a month as institutions continue trading as money truly never sleeps, only for retail traders. The currency market (Forex) is closed for us retail traders during the weekend, but not for everyone. The markets always open for the central banks and the related organizations.
Currency transactions are always done electronically and can not be stopped even for one second. because the price of currency is primarily changed based on the supply and demand, as buying and selling occurs during the weekend as the supply and demand curve changes, thus does price leaving a gap.
So this should explain howtotrade a gap why it occurs. As markets open to us retails traders, the price has gaped compared to the level it was closed on Friday afternoon. If the price opens higher than the Friday afternoon price, we will have a gap up. If it opens lower than the Friday afternoon price, we will have a gap down.
There Are Four Types of Gap Classifications:
- Breakaway Gaps: Gaps that occur at the end of a price pattern and signal the beginning of a new trend.
- Exhaustion Gaps:These gaps occur near the end of a price pattern and signal a final attempt to hit new highs or lows.
- Common Gaps: These gaps don’t get placed in a price pattern; they simply represent an area where the price has “gapped.”
- Continuation Gaps: Continuation gaps occur in the middle of a price pattern and signal a rush of buyers or sellers who share a common belief in the underlying stock’s future direction.
Can We Make Money from the Price Gaps?
When you start learning to trade the markets, you’ll hear that with gap trading the general theory is that “the price always fills the gap”, basically saying that if the price opens with a gap up, it will go down back to cover or fill the gap between the close to the open rate.
In our trading course we actually discuss the probabilities as to how many times this really happens and exactly how to formulate a strategy around it but for the most part it fills the gap… however that’s a real inefficient answer. To find out how we efficiently and precisely trade gaps we recommend joining our entry trading program to learn all 11 strategies based on quantitative statistical data too make you a better trader.
So whats the deal. Yes the gap more times than not will close the gap and there are many trader out there doing this to make money with all different methods and thought processes. But to trade a gap in theory all you have to do is of course identify the gap, and trade in the direction of the gap to close.
Most traders simply enter at the open when they see the gap… I have never done that, and I don’t recommend you to do it too. Why?
First of all, I don’t trade based on what people say. I trade based on probabilities and statistics. If you simply enter at open your not giving yourself a high probable edge as gaps don’t always fill. Secondly markets don’t always go in the direction of the gap right away so you’ll need to think of a way to manage your risk with a stop loss somewhere. You don’t want to be holding a 60 pip knife only to make 20 pips from the gap. The good news however is that we’ve run tests and sampled all the data from the past 10 years of data to come up with a statistical model to place stop loss’s targets and entry rules. You can get access to this strategy and more when you join one of our top rated trading courses
Weekend Gaps and Your Pending, Stop Loss and Target Orders
There is an important question that often new traders ask not only for weekend gap trading but forex trading in genera when learning to trade the markets.
What will happen to buy/sell pending orders including the stop loss and target orders when there is a weekend gap?
So let’s break it down, we either have a position, and this position had a stop loss and target order, or we have some buy/sell pending orders to enter the market when the price reaches to the desired level. If we hold our positions and pending orders during the weekend, and then the market opens with a gap (either down or up), what will happen to our pending orders?
Will they be triggered exactly where they are set, or they will be triggered where the market opens?
The simple answer is no, but it depends on your broker. If you have a guaranteed stop set up with them then yes. But say you didn’t have this set up what will happen?
Well first of all you have to realize that a stop loss, take profit and even a pending order to enter – these are all orders. Its not some magical thing apart of your platform but an automated routing system telling the market you wish to exit or buy at this price ect.
So here’s your options.
You Have a Long Position:
- If the market opens below the stop loss order, then your position will be closed where the market is opened, not where the stop loss order is set, and so, you will lose the stop loss plus the difference of the stop loss and the market open level (outrage). The stop loss is irrelevant and the market has “slipped”. Price can sometimes even slip and not trigger the stop loss at all.
- If the market opens above the target, then your position will be closed where the target is set, so that you will not gain more than your target (outrage) but depends on your broker so ask!
- If the market opens between the stop loss and entry, then the position will remain open until you close it, or the price hits the target or stop loss while the market is running.
- If the market opens above your entry and below the target, then it will not be closed and will remain open until you close it, or the price hits the target or stop loss while the market is running.
You Have a Short Position:
- If the market opens above the stop loss on Sunday afternoon, then the position will be closed where the market is opened, not where the stop loss is set, and so, you will lose the stop loss plus the difference of the stop loss and the market open level (outrage).
- If the market opens below the target, then your position will be closed where the target is set, so that you will not gain more than your target (outrage).
- If the market opens between the stop loss and entry, then it will not be closed and will remain open until you close it, or the price hits the target or stop loss while the market is running.
- If the market opens below your entry and above the target, then it will not be closed and will remain open until you close it, or the price hits the target or stop loss while the market is running.
You Have a Buy Pending Order:
- If the market opens above your buy pending order, then you will enter where the market is opened, not where the order is set. It means your entry price will be higher than where you wanted to enter (outrage).
- If the market opens below your buy pending order, then you will not enter, and your pending order will remain intact.
You Have a Sell Pending Order:
- If the market opens below your sell pending order, then you will enter where the market is opened, not where the order is set. It means your entry price will be lower than where you wanted to enter (outrage).
- If the market opens above your sell pending order, then you will not enter, and your pending order will remain intact.
Does It Means that You Should Not Hold Your Positions and Pending Orders During the Weekends?
This is what everybody may think but in most cased it depends. We can get stung at times but we can also win big just make sure to close out your position if that’s the case.
The truth is if you have a “strong setup” open before the weekend then in most cases the weekend gap will not be against you, and will be in your favor.
If you are worried about the pending orders, you can cancel/delete all of them on Friday afternoon, and set the new ones after the market open on Sunday afternoon (of course if you still want to take those positions).
So pending orders will not be any problems.
There is another question left:
What if the market opens with huge gap against us, even if our position is taken based on a very strong setup?
Everything is possible in trading. Like Murphy’s law suggest’s “things will go wrong in any given situation, if you give them a chance,” or more commonly, “whatever can go wrong,will go wrong”.
It is possible that the market opens with a huge gap against you, even when your position is taken based on the strongest trade setup ever. You can lose a lot. However, there are a few things you have to consider:
- Huge gaps rarely form on the markets, and they rarely can be against you when your position is taken based on a strong setup.
- The way that we manage our accounts and losses, we will not get hurt, even if we lose a lot because of a huge gap.