TECHNICAL ANALYSIS
to occur around the middle section of a price move (such as a trend). (chart 2)
Exhaustion Gaps: Tis type of gaps occurs at the end of a significant price move. For example, in an uptrend price will lead forward in a last attempt to reach higher highs or lower lows (in a downtrend). Nevertheless, price quickly starts to move below the exhaustion gap. Te confirmation for an exhaustion gap should be the close of a trading period below the gap. (chart 3)
Gaps as a Trading Opportunity
Gap trading as any other trading style such as trend following, price breakout trading, and price pattern based strategies involves a level of risk. Terefore, risk management and effective stop loss placing will be critical to succeed with gap trading opportunities.
Furthermore, the initial spike may have been fueled by overly optimistic or pessimistic expectations by the market participants, therefore, suggesting the possibility of a correction in the opposite direction.
Trading Considerations for Effective Gap Trading
Tere are certain guidelines that can be followed by traders to ensure trading gaps in the best possible manner and taking advantage of these types of trading opportunities:
Locating important conflicting support
and resistance levels that could compromise Finding
the gap’s profitability: support
and
resistance levels will permit to develop a better forecast of when price will retrace, which will allow the gap to be partially or completely filled.
Locating price patterns that have occurred before a gap: price patterns are utilized to classify gaps and will tell you the likeliness for a gap to be filled.
Adjust risk depending on the classification of the gap: there are three types of gaps and each one represents a different irregularity in price. Exhaustion gaps are normally the most likely to be filled as they appear at the end of a price move and a correction is expected. On the other hand, breakaway and runaway gaps are significantly less likely to be filled; therefore they represent more risk to the investor as they signal and confirm the direction of a current price move.
The “Gaps Are Always Filled” Myth.
Price gaps do represent a reliable trading opportunity and require a strong understanding of money management and risk control. Gap trading as any other trading strategy allows for traders to develop misconceptions. One of the biggest misconceptions is that gaps “are always filled”. Even though gaps are filled in several occasions, gaps may not be filled every single time.
FX
Te markets are not constant and they tend to change abruptly. A gap represents an irregularity in the forces of demand and supply and they can be expected to happen in highly volatile and in low volume periods.
A gap pattern provides us with information regarding the current market conditions which allows us to forecast future price action. However, it is important to remember that there is always risk involved and that not every gap trade will be profitable or will always get filled.
Trading Ideas for Market Gaps
Trading a gap by attempting to
capture 50% to 75% of the total size of the gap: gaps are price patterns created by a sudden change in the beliefs of the market participants expressed through their trades. A professional approach to trading gaps would be setting realistic profit targets that attempt to capture 50% to 75% of the size of the gap. This will permit for the trader
to still
capture profits if the gap is only partially filled.
Utilizing measuring gaps to calculate profit target levels: Measuring gaps tend to appear in the middle area of a major trend. This allows the trader to calculate the size of the continuation of a trend and find appropriate profit targets for their trades.
FX TRADER MAGAZINE July - September 2013 41
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