The price of a financial product moves continuously. However, from time to time, a “gap” occurs. Trading gaps is not a one-way street, though. Depending on the financial product, different ways of trading gaps for daily profit exist. Moreover, like this article will show, day trading gaps differs from culture to culture.
Charting as a way of forecasting prices evolved in time. A few decades ago, everything was done manually.
Today, with high-speed personal computers available to any individual, charting is easy. Technical analysis changed because of that.
Classical patterns, like the head and shoulders pattern, triangles, bullish or bearish flags, etc.…appear automatically on a chart. There’s a simple robot or EA (Expert Advisor) that does that.
But, some things never change. Trading gaps fascinated financial communities since technical analysis’s beginnings.
As this article will point, two main interpretations to day trading gaps exist. One attributed to the Western world. And, the other one to the Japanese traders.
Both embrace the fact that price moves super-fast. Because of that, the opening of a new candle will differ from the closing of the previous one.
However, gaps do not appear on all chart types. For example, if one uses a line chart for his/her analysis, trading gaps for daily profit is more difficult. That is because traders cannot identify them easily.
Technical analysis started with traders tracking prices of an underlying security. They noted down the daily movements of it.
In time, these movements formed a chart. But, to the surprise of any newcomer in the field of technical analysis, empty spaces formed.
The chart is not a continuing line. Those empty spaces, the so-called “gaps” shape the way the market move next.
And, the way traders approach trading after a gap forms…
Defining a Gap – Trading Gaps for Daily Profit
When there’s a difference between the opening price of a new candle and the closing price of the previous one, a gap forms. The bigger the difference, the bigger the gap is.
In the Forex market, gaps have a special place. They rarely form during the trading week.
Because the Forex market is a 24/5 market, it follows the sun. During the trading week, virtually there’s no gap. However, with some exceptions, we’ll cover later.
Brokerage houses these days use superior execution technologies. STP (Straight Through Protocol) and ECN (Electronic Communication Network) are the norm.
As such, brokers route their clients’ orders to multiple liquidity providers. The more liquidity providers, the better. Why?
That’s easy to answer. The broker will choose the best/closest price to its client’s order.
For this simple reason, there’s little or no difference between candles. No matter the time frame.
Therefore, there are fewer gaps on the Forex market. However, they do appear. But, trading gaps is no easy task.
They say Forex is closed for the weekend. That’s correct. But, only to some extent.
Consider the reality of the world we live in. Over the weekend plenty of things happen/may happen.
Political events (elections, referendums, summits, etc.), geopolitical movements, monetary policy decisions, wars may start or end, etc… all these create volatility. When volatility rises on the Monday’s opening, gaps form.
Trading gaps for daily profit is tricky. Many retail traders got burn looking for the perfect gap trading strategies. There’s no such thing.
Instead, gaps show imbalances between supply and demand. Or, imbalances between bulls and bears strength.
The Western Approach to Trading Gaps
Technical analysis originated in the West. As such, it is no wonder there’s a Western approach to gap trading.
But, this approach is quite old. Like many trading theories, the rules come from the stock market.
However, we all know today’s Forex market has nothing to do with the way stocks move. Hence, we should treat it with a grain of salt.
There’s a controversy even on how to define a gap. Some say it is the empty space between two consecutive candles.
Others, it is the empty space between the opening price on Monday. And, the closing one on the previous Friday.
Such ambiguity makes trading gaps for daily profits difficult. How do you define Forex gaps?
The chart above shows the EURUSD reaction to the 2017 French Presidential Election. Over the weekend, French people favored a pro-European candidate.
All Euro pairs gapped higher.
The Western approach to trading gaps for daily profit calls for all gaps to close. That is, for the price to come back to the previous Friday’s close.
As the chart above shows, trading gaps is not straightforward. Not only that price didn’t return to close the gap but now trades much higher.
In technical analysis terms, the day trading gaps strategy didn’t work. The gap is still open.
When trading gaps for daily profit, and using the Western approach to it, gaps should fill that same Monday. Or, according to some, next Friday at the latest.
However, today’s reality differs. There are plenty of examples with gaps that are still open to this day.
Simply do an exercise. Go on the EURUSD chart and open the four-hour time frame. You’ll notice a gap around the 1.20 level. It is still open form more than two years now.
Difficulties when Day Trading Gaps
That gap is still open form more than two years now. It doesn’t mean it won’t close, eventually.
But, the Western approach to trading gaps failed.
However, most of the gaps do close on Monday. Or, at the latest, by next Friday.
Unfortunately, there’s no way to differentiate between the two. Which one is a “fake gap” and which one will close quickly?
As such, trading gaps for daily profit may end up in great losses. Because traders believe it is mandatory for the gap to close, they keep adding to the same position. That is the same wrong position.
Day trading gaps gets even more difficult. Forex brokers make sure you’ll have a hard time for that.
Lately, the trend is to get rid of the Sunday candle. That means Forex brokers effectively move the geographical position of their servers.
In doing that, day trading gaps strategies suffer a major blow. On Sundays, there’s trading taking place in New Zealand.
For a few hours, buyers and sellers change hands. If there’s no Sunday candle due to server’s location, the opening gap trading strategies won’t work.
Because the opening price is two hours or so late, the edges of the gap differ. Therefore, trading gaps with a strategy must consider where the broker’s servers are.
Trading the Gap – Western Style
As mentioned earlier, trading gaps for daily profit using the Western approach do work. Most of the times.
But, in Forex trading, “most of the times” often results in a great gap Forex strategy. Traders built specific rules for closing a gap.
As such, day trading gaps strategies focus more on time, than on price. After all, traders already know the price (the gap’s edges).
Below is the famous “Cyprus gap”. On a famous 2013 Sunday, the European Central Bank together with other financial institutions decided to confiscate part of private people’s deposits in Cyprus banks.
The technical terms don’t matter. From a trading point of view, the market opened with a huge gap to the downside.
However, a Western based Forex gap trading strategy worked. Eventually, the gap closed sooner rather than later, right at the close of that week.
Still, it is a tough call trading gaps like this one. How do we know, as traders, which gap will close by the next Friday? Or, which one will close on Monday?
Or, even more difficult: is there a Forex gap strategy that really works?
Trading Gaps for Daily Profit – the Japanese Approach
The Japanese approach to technical analysis was unknown. Until recently.
The innovative ways to look at markets captivated the Western world. As such, the Japanese techniques became known worldwide.
Candlesticks were introduced to the Western world too. Because of them, technical analysis will never be the same.
To put this into perspective, nowadays, Japanese candlestick charts are the most popular ones. Not only among retail traders.
The Ichimoku Kinko Hyo changed the way traders look at support and resistance levels. Just to name a few major inputs from the Japanese side to technical analysis.
However, the way Japanese technical analysis treated gaps blows minds. There’s a clear day trading gaps strategy as a result.
Rising and Falling Windows – Gaps in Forex Charts
The Japanese candlestick techniques as we know them today show mainly reversal patterns. But, there’s one exception: the Doji candle. Doji’s show both continuation and reversal conditions.
Yet, the most innovative way comes from the Japanese way to trading gaps for daily profit. The Japanese call gaps “windows”.
As such, windows can fall or rise. Hence, there’s a rising or falling window.
In Western terms, a rising window is a gap higher. And, a falling window forms when the market gaps lower.
A Forex weekend gap trading strategy in Japan considers the windows continuation patterns. Not reversal ones!
This is a new way to trade gaps in Forex. Moreover, day trading gaps will never be the same.
The chart above shows a rising window. The price over the weekend gaps and a window forms.
Under the Western approach, trading gaps like this one is simple. The market closed it soon.
But, there’s another way to look at it. The Japanese way.
According to this approach, trading the gap doesn’t stop here. The window’s edges will act as strong future support and resistance levels.
Look closer on the right side of the chart. When trading gaps for daily profit, look for the edges to offer great risk-reward trades.
Traders use them as classical support and resistance levels. Not dynamic ones!
In other words, the old rules apply here too. The moment the price closes above the rising window, the two edges become support.
Until them, they act like resistance. That’s new thinking in technical analysis!
This gap gave a great trade. The difference between a standard day trading gaps approach is huge.
It appeared nine weeks after the rising window formed. Moreover, this trading gaps approach will provide support or resistance levels every time the price hits the two edges.
Gaps in Forex Charts
Not all markets act the same. There’s a saying in trading: no financial product is the same.
As a matter of fact, this holds true in the Forex market too. No two currency pairs are alike.
Some are more volatile. Others range most of the time. The same with day trading gaps strategies.
The USD plays a central role. After all, it is the world’s reserve currency.
As such, the dollar pairs, also called the major pairs, travel the most. The rest, the crosses, range most.
But still, in both cases, gaps occur only over the weekend. Is this a general rule when trading gaps for daily profit?
Is it possible for gaps to appear in the middle of the trading week? Unfortunately, yes. And, there’s nothing in the world that can protect traders.
The SNB and the EURCHF – Trading the Gap During Market Hours
For years, the SNB (Swiss National Bank) held the EURCHF pair at 1.20. It was a fixed rate designed to stop CHF appreciation.
The system worked like a charm. That is until it broke.
All those years, retail traders (and not only!), bought the EURCHF against 1.20 stop loss. After all, one of the most influential and respected central banks in the world assured buying at that level.
Because massive losses it took, the SNB decided to drop the peg. The ECB (European Central Bank) was about to announce a massive quantitative easing program.
As such SNB couldn’t afford to keep the peg anymore. In January 2015, it let it go.
The chart above shows the effect on the EURCHF pair. While a gap is not visible, one existed.
You see, for some minutes, the market on the CHF pairs ceased to exist. Moreover, after five minutes or so, traders found out the market was about a few thousand pips lower.
This article explained how ECN and STP execute orders. But, there’s a big if.
The broker executes an order IF there’s a market. In this case, it wasn’t all the way down to 0.86.
For days, the gap appeared on every CHF chart. This one included.
But, it formed during the market hours. Is it possible trading gaps like this? The answer is no.
Brokers quickly realized this and covered the negative balances for most retail traders. Even those that didn’t, they changed the charts.
Nowadays, if you don’t know what happened, you won’t know day trading gaps differ when a gap forms during market hours.
Trading Gaps for Daily Profit in the Stock Market
While this article covers Forex gap trading strategies, we cannot ignore the stock market. Most of the times, the two move hand in hand.
To give you an example, when a central bank moves rates, both markets travel. When inflation comes out, both market move. And so on.
As such, it is worth mentioning that gaps form often on the stock market. Don’t believe me, though! Check out the chart below.
There are gaps all over the place. In fact, trading the gap on the stock market differs from the weekend gaps trading Forex traders use.
The idea here was simply to show that each market has its own way of treating gaps.
Trading gaps differ from market to market. When trading gaps for daily profit on the Forex market, traders face a tough decision.
There’s no way to tell which gap closes by the end of the day. Or, by the end of the week.
Even more important, what to do with the gaps that stay open for years? Will the ever close?
If they do, eventually, there’s still no day trading gaps strategy to use. The market travels too far and too fast to have one.
Yet, the Japanese approach to trading gaps seems to be more accurate. And, more complete.
It doesn’t treat gaps as mandatory to close. Moreover, when a gap closes, its edges still give great trades.
The bigger the gap, the stronger the support and resistance level given by its edges.
One thing is for sure: edges appear on all time frames. And, they don’t change. That is if you know what makes a gap. Where is a gap starting and when it ends?
To complicate things even further, Forex brokers won’t help. This comes as a huge disadvantage for the Japanese approach to gaps.
If the edges are not accurate, future support and resistance levels appear in the wrong place. Therefore, the analysis leads to different values. It depends very much if the broker shows a Sunday candle or not.
To sum up, there’s no one-way to trading gaps. Day trading gaps should be an integrant part of a money management system.
Clear rules will keep traders on the safe side of the market. Otherwise, they’ll end up hoping for a gap’s close, only to see the market going further and further away.
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