What Is Gap Trading?
Gaps in the Forex market help traders identify price movement clues, entry and exit signals, and trend reversals. In simple terms, gap trading is a disciplined approach to buy and sell assets. You can benefit from volatile markets in asset prices or gaps and turn these gaps into trading opportunities. Let's take a deep dive into what gaps are and how you can make the most of gap trading:
What is gap and gap trading?
A gap refers to the difference between the currency pair opening price and the previous day’s closing price. Any sharp upward or downward movement in the currency pair price can be termed as a gap. In gap trading, the traders find currency pairs that open at a higher price or an extremely low price than its previous day’s closing price, monitor its movement, and make a trade. Gaps can be identified as candlesticks on the Forex chart pattern, and sharp price movements are notably visible with low liquidity in the trading volume. Here’s how you can identify gaps:
- Look for strong support and resistance levels in the market
- If there is a strong resistance level and the currency pair price moves beyond that level before coming back to its original position, it signals to sell the currency pair
- If there is a strong support level, and the currency pair price moves below this level before coming back to its original position, it signals to buy the currency pair and limit losses
Four main types of gaps you need to know
1. Breakaway gaps
Breakaway gaps identify the strongest support and resistance price levels. They generally mark a trend reversal while moving out of a current trend.
2. Common gaps
Common gaps refer to a non-linear drop or jump from one currency pair price to another. As the name suggests, these gaps are the most common gaps to witness.
3. Exhaustion gaps
Exhaustion gaps occur when a steep decline in a currency pair’s price happens after a rapid increase. This gap signals traders that there is now a fall in the demand for the currency pair.
4. Runaway gaps
Runaway gaps in the Forex market occur in the middle of an existing trend. It occurs in the trend’s direction and is a gap that exceeds 5% of the currency pair’s price.
Top four gap trading strategies for Forex traders
1. Full gap trading strategy
The full gapping trading strategy occurs whenever a currency pair opens at a price that is above and beyond the previous day’s closing price. Full gaps indicate a strong market sentiment shift and send entry and exit signals to the traders.
- Whenever prices open beyond the previous day’s high price, it sends a long position or buy signal
- When prices drop below the opening price in the first trading hour, it sends traders a sell or short position signal
- Any sharp decline in the prices when compared to the previous day’s closing price and a day before’s low price, signals traders to place a long position order
- When a currency pair opens below the previous day’s lowest price, it sends a signal to the traders to short the trade immediately
2. Partial gap trading strategy
The partial gapping trading strategy occurs whenever the currency pair’s opening price moves beyond or below the last day’s closing price. But the opening price remains within the last day’s pricing range. The partial gap trading strategy allows traders to place trailing stop orders of around 6%.
- Whenever the currency pair opens beyond the previous day’s closing price, but below the previous day’s high price, it sends traders a signal to buy more of the currency pair
- Whenever the price for the current day is lower than the previous day’s closing price, it sends traders a buy signal
- Whenever the currency pair opens at a price less than the previous day’s closing price, it signals traders to short the trade
3. End of day gap trading strategy
The end of day gap trading strategy involves the traders scanning and reviewing the currency pairs at the end of the trading day to analyse which ones have the best potential. Since the Forex market functions 24 hours a day, from Sunday to Friday, the end of the day for Forex traders is 5:00 P.M. EST on Fridays. The volatility during this hour sends a strong indication to traders about the continued movement in the market along the gap’s direction.
- Whenever the currency pair price witnesses a gap that goes beyond the resistance level, it sends the traders an entry signal for the upcoming next week
- Whenever the prices witness a gap that moves below the support level, it sends the traders an exit signal in the market for the upcoming new trading week
4. Modified gap trading strategy
In a modified gap trading strategy, a trader places positions in the middle of a market trend. The only requirement to trade the modified gap trading strategy is that the currency pair must be trading twice (at least) the average trading volume since the last five trading days.
- Whenever a currency pair opens at the previous day’s highest price, it sends the traders a buy signal. The price for the long or sell order should be equal to the average of the high price and opening price for the current day’s first trading hour
- Whenever the price opens at less than the previous day’s lowest price, it sends a sell signal. The price for the long or sell order should be equal to the average of the low price and opening price for the current day’s first trading hour
Gap trading strategies to use in your trades
Trading the currency pair price’s gap enables you to identify potentially profitable positions. Blueberry Markets is a trading platform that delivers all the charts and informational material about different Forex trading strategies that you can apply to maximise your profits and minimise your losses. Sign up for a live trading account or try a risk-free demo account.
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