You might have often seen gaps on the price charts. You might have also wondered why do these gaps occur. Mostly we see the gaps when a new week begins. You can use these gaps in your favor while trading. You can devise a trading strategy with an acceptable risk to reward ratio. Let’s explore an uncommon trading strategy based on gaps.
What is a gap?
A gap is a space that occurs on a chart when a price moves up significantly; if some vital news comes to light once the price of a stock is closed, there is a good chance you will see a gap on the charts the very next day. Apart from news releases, we may find gaps when the new week begins. Due to low liquidity, you may find higher spreads when a gap appears. However, gaps occur most commonly in stocks than in Forex.
Why does a price gap happen?
There are quite a few reasons why a gap may occur on a chart. Sometimes, an exchange fails to manage to obtain the information of how the price is changing at the right time. This is what leads to blank spaces on the chart. But, when it comes to trading, the traders are more interested when a gap occurs naturally and not just because of stock tanks. It can be referred to as a drastic change in the market.
Hypothetically, if the market opens up and there is an up gap, there is an excellent chance of a strong uptrend. But, if the opposite happens, there will be likely a continuous downtrend. Such kind of gaps usually take place during trading sessions.
How to interpret Forex gaps?
Forex gaps usually happen when there is an unexpected turn of events, and these gaps are generally not that big. For most of it, the opening price and the closing price are usually the same. An example of a profitable gap trading strategy would be to open a position against a gap. Then there is hope that the price will fix it.
Why does a price fill a gap?
A price needs to fill the gap with the big guns of the markets referred to as the market makers. It is also a common phenomenon that the market makers either push the price too high or too low, especially between trading sessions. Since they have quite a few resources with them, market makers usually trade against the trend.
Market makers confuse the traders even further by closing the gap altogether. After the gap has been completed, the traders might start trading in the direction of the gap, forming a strong trend.
Bottom line
Price gaps can provide you with great trading opportunities. You can trade the gaps based on your trading strategy. The method has a higher rate of success, but losses are inevitable in forex trading. Hence, you should not blindly risk with the strategy. Rather, use some confirmatory analysis tools to add further odds of success. Never risk more than 1% capital in a single transaction.
