How to trade gaps
Gap is an area on a chart which is not filled with any technical objects, where no trades took place. Gaps usually occur in the interim of two sessions. If something important happens (data releases, significant political announcements), the market volatility increases and Bid/Ask spread widens resulting in a gap. The gaps often occur at the week’s opening if there were some big news during the weekend.
There are 4 types of gaps – breakaway, exhaustion, common and continuation.
Breakaway gaps usually warn us of imminent market reversals. They occur at the end of the price pattern and indicate the beginning of the new trend. Normally these gaps remain unclosed.
Exhaustion gaps are also formed at the end of price patterns, but, contrary to the breakaway gaps, they appear when price makes the last effort to continue the trend and achieve new lows or highs. They have closed shortly afterward.
Common gaps occur when the quotes move sidelines if prices are not included in any price patterns.
Continuation gaps (runaway/measuring gap) occur in the middle of a price pattern and tell us that buyers or sellers want to form the pattern as soon as possible.
How to trade
‘The gap is filled’ is an expression which is used when price moves back to the point where it had been before the gap. Such gap fillings occur very often. Many traders learned how to trade them and invented numerous strategies to make as much money as possible.
You should follow the newscasts especially at the end of the week and search for the event that could produce trading discontinuities on the technical chart. Once you manage to do so, you will be well-positioned at the beginning of the week and prepared to trade on the gaps. If the price starts to fill a gap, it doesn’t cease until the gap is closed as there are no any significant resistances/supports that could impede the price actions.
It’s also useful to see what amount of liquidity is on the market. If it’s a bank holiday in one of the major economy and liquidity is low, it may be sensible to buy when the market is trying to close a bearish gap and there’s no strong resistance ahead.
Some traders prefer to fade gaps in the opposite direction once the price has set a high or low after the gap. For example, if a currency gaps up on some important event, skillful traders may fade the gap by shorting the currency.
Sometimes traders might be willing to buy when the price reaches the previous support after the gap has been filled.
There are many trading strategies that benefit from the “gap filling”. Before initiating any trade on gaps, you should define the type of the gap. Pay attention to the volume (high volume corresponds to the occurrence of breakaway gaps; low volume – to the exhaustion gaps). Good luck in your trades!