Forex Gap Trading Strategies

Forex Gap Trading Strategies

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Gap trading strategies allow traders to benefit from price gaps caused by sudden fluctuations between trading sessions. Weekend price gaps are common in the Forex market and usually get filled soon after trading resumes on Mondays. Gap trading can be a very lucrative strategy that is suitable for forex beginner and professional traders.

What is a Gap?

Gaps are areas on charts where prices move sharply on the upside or the downside, creating a price gap. Trading gaps usually occur following unexpected events, data releases or due to technical factors and low market liquidity.  Because the forex market operates 24 hours a day and 5 days a week, gaps are more common in forex trading than other financial markets.

Price gaps take place mostly on Mondays when the market opens at a different price from the closing price from the previous Friday. Unexpected events during weekends are the main factor behind opening gaps in the forex market.

A gap gets filled when the price returns to the same price level at which the gap was triggered. Gap filling can be affected by multiple factors that include:

  • Price corrections that follow a price gap.
  • The price faces a strong support or resistance after moving up or down sharply.
  • The likelihood of a gap being filled is higher when a price pattern is formed. Same applies to exhaustion gaps that indicate a trend reversal.
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Types of Gaps in the Forex Market

There are four popular types of forex price gaps as follows:

Common Gaps

Common gaps, also known as trading gaps or area gaps, occur frequently with no major implications on future price movements. They usually happen in ranging price movements, and are commonly known for being relatively small in size and get filled fast. Unlike other types of gaps, common gaps offer fewer trading opportunities.

Breakaway Gaps

Breakaway gaps happen when price gaps near support and resistance levels or at the end of a pattern where a new trend is about to begin. This type usually happens when the market breaks out of its current phase to a prolonged one. At this point, a breakaway gap is formed signaling strong momentum that keeps prices trending. The wider the gap, the stronger the following price movement will be.

Forex Gap Trading - Breakaway Gaps

Runaway Gaps

Also known as continuation gaps, runaway gaps occur in the middle of a price trend signaling its continuity. Trading runaway gaps can be more profitable when merged with technical price analysis. An upward runaway gap shows that additional buyers have entered the market to push prices higher. Reversely, when more sellers enter the market pushing prices lower, and creating a sharp price gap.

Forex Gap Trading - Runaway Gaps

Exhaustion Gaps

Exhaustion gaps usually appear at the end of a trend signaling a potential reversal as momentum begins to wane. An exhaustion gap is identified by a final gap in the same direction followed by a Doji candlestick that reflects the struggle between buyers and sellers. In order to avoid running into false signals, it is recommended to wait for the completion of the candle to confirm the trend reversal. Read more on trend analysis and how to use price trends in forex trading.

Forex Gap Trading - Exhaustion Gaps

Forex Gap Trading Strategies and Tips

Forex traders capitalize on price gaps triggered by high price fluctuations. Here are some elements to consider when trading gaps in the forex market:

  • Identify the gap you’re going to play: It’s crucial to know which type of gaps you are going to trade as every type implies a different price movement.  For example, a continuation gap reflects an intensified trend while the exhaustion gap indicates that a trend is about to reverse.
  • Gap trading means trading market volatility with low liquidity which can be risky. Read more on trading psychology and make sure you’re trading with a solid trading mindset while following a proper risk management plan.
  • Consider the trading volume. Breakaway gaps, for example, usually reflect high volumes while exhaustion gaps are triggered by low volumes.
  • Trading weekend price gaps is a very simple and profitable strategy. Traders usually open positions following a gap, and wait until it is filled. The gap is more likely to be filled faster if it is in the same direction of the long-term trend.
  • Consider opening a position in the direction of the fill using a tight stop loss when the price action signals a strong move is likely underway.
  • Price gaps in high volume pairs such as the EUR/USD are more likely to be filled fast. For other currency pairs, gaps can only be filled quickly if the gap’s size doesn’t surpass 75 pips in size.
  • For more profitable forex gap trading, it’s important to observe the price action on shorter time frames.

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