The forex gap trading strategy is a remarkable price action trading system which is based on a phenomenon also known as the forex gap. It is a trading strategy which is based on the daily timeframe, and there is no need of using forex indicators for this.
What is a forex gap?
A forex gap in forex trading occurs when the opening price of a candlestick is not similar to the close of the previous candlestick. There is usually a space or gap in between the close and the opening of the candlesticks. In the share market, share traders are known to trade gaps since it is much more common.
Since the stock market closes each day, gaps are quite common. The concept behind the forex gap trading is that the price will always try to fill the gap. Even though this does not sound logical, there are some reasonable reasons for a price to fill gaps in the stock market. By and large, when price gaps, there is usually no support and resistance in the gap area. This implies that the price is free to move inside the gap.
What is gap trading?
Stock, as well as commodity traders, have exploited forex gaps for many years. Since the stock market shuts down each day, gaps are much more common. The concept behind it is that the price will always try to fill the gap.
Trading gaps is fundamentally a matter of choice. While some traders swear by trading gaps, other traders give it a wide berth. Some traders have realized that depending on a specific currency pair; the gap is likely to be filled most of the time. Such traders, therefore, feel comfortable trading the gap.
On the other hand, other traders think that the gaps do not always get filled and that they tend to be filled less often than not. Such traders avoid trading the gaps. The truth is that the gaps may be profitable should you decide to use the right currency pairs or stock indices and if the markets tend to fill gaps more often than not.
Should you choose to trade the gaps, you need to bear in mind a couple of things. First and foremost, always use a currency pair or market that is volatile. This is because the gaps tend to be wider and the probability of most of them being filled is greater than currency pairs with less volatility.
Once you have identified the right currency pair, you should then look for trading gaps on Sunday evening or Monday morning. This is dependent on when your broker starts trading after the weekends.
With this type of trading, some traders believe it is best to avoid stop losses and take profits since the bottom, and the tops of the gaps naturally act as stop loss and take profit points.
However, some traders are of the view that stop losses always ought to be used and should be set as key resistance or support levels. This is very instrumental in assisting to avoid huge losses. By and large, the choice is largely dependent on the choice of each trader by his risk assessment.
Types of gap classifications
Breakaway gaps: these types of gaps take place at the end of a price pattern and signal the beginning of a new trend.
Exhaustion gaps: these are the types of gaps that occur near the end of a price pattern and signal a final attempt to hit new highs or lows.
Common gaps: these are gaps which do not get placed in a price pattern. They usually represent an area where the prices have ‘gapped.’
Continuation gaps: take place in the middle of a price pattern and signal a rush or sellers or buyers who have a common belief in the underlying stock’s future direction.