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In the world of finance, traders are always looking for an edge to help them generate profits. One strategy that has gained popularity in recent years is using fair value gaps in trading. In this article, we will explore what fair value gaps are, how they can be identified, and how traders can use them to develop a profitable trading strategy. We will also discuss the risks and challenges associated with fair value gap trading.

What Is a Fair Value Gap?

A fair value gap is especially popular among price action traders and occurs when there are inefficiencies or imbalances in the market, or when the buying and selling are not equal. Fair value gaps can become a magnet for the price before continuing in the same direction.

On a chart, a fair value gap appears in a triple-candle pattern when there is a large candle whose previous candle&#;s high and subsequent candle&#;s low do not fully overlap the large candle. The space between these wicks is known as the fair value gap.

Quick Tips:

Fair Value Gap Trading Strategy

The first step in this strategy is to identify fair value gaps. This can be done either manually by looking for the triple-candle pattern mentioned previously or by using a fair value gap indicator that highlights fair value gaps automatically on the chart.

Once a fair value gap is identified, traders wait for the price to revert back towards the fair value gap to clear out the imbalance before continuing to move in the direction of the prevailing trend.

For example, if a fair value gap is created in a move to the upside, traders would wait for the price to be pulled down toward the fair value gap and enter a long position with the goal of profiting from a continued move to the upside once the imbalance is cleared out.

Conversely, if a fair value gap is created in a move to the downside, traders would wait for the price to revert up toward the fair value gap and enter a short position with the goal of profiting from a continued move to the downside once the imbalance is cleared out.

The fair value gap trading strategy requires a disciplined approach to risk management, as traders need to be prepared for potential losses if the market does not move in the direction they anticipate. Traders can mitigate this risk by setting stop-loss orders to limit their losses and by using appropriate position sizing to manage their exposure to the market.

Pros and Cons of Fair Value Gaps

Like any trading strategy, there are both advantages and disadvantages to fair value gaps. Here are some of the pros and cons:

Pros:

1. Profit potential: If a trader can accurately identify a fair value gap and trade on it, they can potentially earn significant profits.
2. Reduced risk: Because fair value gap trading is focused on identifying inefficiencies in the market, it can be less risky than other trading strategies that rely on making directional bets on the direction of an asset&#;s price movement.
3. Flexibility: This strategy can be applied to a wide range of assets, including stocks, bonds, commodities, and currencies.

Cons:

1. Risk of misjudgment: The fair value gap trading strategy relies on the assumption that the asset&#;s price will reverse once a fair value gap is filled, but this is not always the case. The asset&#;s price could continue to move through and past it, resulting in losses for the trader.
2. Market volatility: The market can be unpredictable, and even small movements in market prices can lead to significant losses for fair value gap traders.
3. Limited opportunities: The opportunities for fair value gap trading may be limited in some markets, particularly in highly efficient markets.

In summary, fair value gaps can offer profitable opportunities for experienced traders who have the skills and knowledge to identify inefficiencies in financial markets. It is important for traders to carefully consider the pros and cons before implementing this strategy.

Example scanners to easily find Fair Value Gaps

Fair Value Gaps can be used in Scanning the market. To see how exactly it can be used in this way, we provide the following samples. Both scanners search the market for stocks using this indicator.

eunic-brussels.eu

&#;Bullish Fair Value Gap&#; scanner by TrendSpider

eunic-brussels.eu

&#;Bearish Fair Value Gap&#; scanner by TrendSpider

These fair value gap scanners utilize the price conditions that define a fair value gap to allow traders to instantly identify fair value gaps forming in real-time. Traders can import these scans directly into their accounts, save them as their own, and customize them via additional price, indicator, candlestick pattern, or other criteria.

The Bottom Line

In conclusion, the fair value gap trading strategy can be a lucrative approach to the financial markets. By identifying inefficiencies with fair value gaps, traders can take advantage of the temporary imbalances that arise in the market. Overall, it is important for traders to carefully consider the risks and rewards of the fair value gap trading strategy and to develop a thorough understanding of the markets in which they operate. With the right approach and mindset, the fair value gap trading strategy can be a profitable and rewarding endeavor.

Quick Tips:

• Fair value gaps can sometimes lead to or be created by breaks in Market Structure
• Order Blocks are another powerful tool that fair value gap traders like to utilize

Gaps in the Forex market help traders identify price movement clues, entry and exit signals, and trend reversals. In simple terms, gap trading is a disciplined approach to buy and sell assets. You can benefit from volatile markets in asset prices or gaps and turn these gaps into trading opportunities. Let's take a deep dive into what gaps are and how you can make the most of gap trading:

What is gap and gap trading?

A gap refers to the difference between the currency pair opening price and the previous day’s closing price. Any sharp upward or downward movement in the currency pair price can be termed as a gap. In gap trading, the traders find currency pairs that open at a higher price or an extremely low price than its previous day’s closing price, monitor its movement, and make a trade. Gaps can be identified as candlesticks on the Forex chart pattern, and sharp price movements are notably visible with low liquidity in the trading volume. Here’s how you can identify gaps:

• Look for strong support and resistance levels in the market
• If there is a strong resistance level and the currency pair price moves beyond that level before coming back to its original position, it signals to sell the currency pair
• If there is a strong support level, and the currency pair price moves below this level before coming back to its original position, it signals to buy the currency pair and limit losses

Four main types of gaps you need to know

1. Breakaway gaps

Breakaway gaps identify the strongest support and resistance price levels. They generally mark a trend reversal while moving out of a current trend.

2. Common gaps

Common gaps refer to a non-linear drop or jump from one currency pair price to another. As the name suggests, these gaps are the most common gaps to witness.

3. Exhaustion gaps

Exhaustion gaps occur when a steep decline in a currency pair’s price happens after a rapid increase. This gap signals traders that there is now a fall in the demand for the currency pair.

4. Runaway gaps

Runaway gaps in the Forex market occur in the middle of an existing trend. It occurs in the trend’s direction and is a gap that exceeds 5% of the currency pair’s price.

Top four gap trading strategies for Forex traders

1. Full gap trading strategy

The full gapping trading strategy occurs whenever a currency pair opens at a price that is above and beyond the previous day’s closing price. Full gaps indicate a strong market sentiment shift and send entry and exit signals to the traders.

• Whenever prices open beyond the previous day’s high price, it sends a long position or buy signal
• When prices drop below the opening price in the first trading hour, it sends traders a sell or short position signal
• Any sharp decline in the prices when compared to the previous day’s closing price and a day before’s low price, signals traders to place a long position order
• When a currency pair opens below the previous day’s lowest price, it sends a signal to the traders to short the trade immediately

2. Partial gap trading strategy

The partial gapping trading strategy occurs whenever the currency pair’s opening price moves beyond or below the last day’s closing price. But the opening price remains within the last day’s pricing range. The partial gap trading strategy allows traders to place trailing stop orders of around 6%.

• Whenever the currency pair opens beyond the previous day’s closing price, but below the previous day’s high price, it sends traders a signal to buy more of the currency pair
• Whenever the price for the current day is lower than the previous day’s closing price, it sends traders a buy signal
• Whenever the currency pair opens at a price less than the previous day’s closing price, it signals traders to short the trade

3. End of day gap trading strategy

The end of day gap trading strategy involves the traders scanning and reviewing the currency pairs at the end of the trading day to analyse which ones have the best potential. Since the Forex market functions 24 hours a day, from Sunday to Friday, the end of the day for Forex traders is P.M. EST on Fridays. The volatility during this hour sends a strong indication to traders about the continued movement in the market along the gap’s direction.

• Whenever the currency pair price witnesses a gap that goes beyond the resistance level, it sends the traders an entry signal for the upcoming next week
• Whenever the prices witness a gap that moves below the support level, it sends the traders an exit signal in the market for the upcoming new trading week

4. Modified gap trading strategy

In a modified gap trading strategy, a trader places positions in the middle of a market trend. The only requirement to trade the modified gap trading strategy is that the currency pair must be trading twice (at least) the average trading volume since the last five trading days.

• Whenever a currency pair opens at the previous day’s highest price, it sends the traders a buy signal. The price for the long or sell order should be equal to the average of the high price and opening price for the current day’s first trading hour
• Whenever the price opens at less than the previous day’s lowest price, it sends a sell signal. The price for the long or sell order should be equal to the average of the low price and opening price for the current day’s first trading hour

Gap trading strategies to use in your trades

Trading the currency pair price’s gap enables you to identify potentially profitable positions. Blueberry Markets is a trading platform that delivers all the charts and informational material about different Forex trading strategies that you can apply to maximise your profits and minimise your losses. Sign up for a live trading account or try a risk-free demo account.

When to close a position?

The Gap Close strategy uses two profit targets and a stop loss to protect the position. The first profit target corresponds to half the distance of the gap. The second profit target corresponds to the full distance of the gap. Traders tend to open positions which can be split into two, resulting in an equal position size for each profit target. Other split ratios than 50/50 are possible. These can be set, as usual, in the Designer dialog.

The stop loss is a fixed stop. This stop is in essence a safety net as it is placed relatively far from the entry price (default ticks).

What to do when the target(s) are not reached and the stop is not triggered? Manually close the position on Wednesday.

The example shows a short sell signal on the EUR/NZD. Half of the position is closed when the first target (half the gap, green line) is reached. The other half of the position is closed when the market closes the gap. The red line indicates the stop order.

In volatile markets, traders can benefit from large jumps in asset prices if they can be turned into opportunities. Gaps are areas on a chart where the price of a stock (or another financial instrument) moves sharply up or down, with little or no trading in between. As a result, the asset’s chart shows a gap in the normal price pattern. The enterprising trader can interpret and exploit these gaps for profit.

This article will help you understand how and why gaps occur, and how you can use them to make profitable trades.

Gap Basics

Gaps occur because of underlying fundamental or technical factors. For example, if a company’s earnings are much higher than expected, then the company’s stock may gap up the next day. This means that the stock price opened higher than it closed the day before, thereby leaving a gap.

In the forex (FX) market, it is not uncommon for a report to generate so much buzz that it widens the bid-ask spread to a point where a significant gap can be seen. Similarly, a stock breaking a new high in the current session may open higher in the next session, thus gapping up for technical reasons.

Automated program trading (i.e., algorithmic trading) is a relatively new source of gap price action. The algorithm might signal a large buy order if, for example, a prior high is broken. The size of the algorithmic order may be such that it triggers a price gap, breaking above the recent high and drawing in other traders to the directional movement.

Gaps can be classified into four groups:

• Breakaway gapsoccur at the end of a price pattern and signal the beginning of a new trend.
• Exhaustion gapsoccur near the end of a price pattern and signal a final attempt to hit new highs or lows.
• Common gapscannot be placed in a price pattern—they simply represent an area where the price has gapped.
• Continuation gaps, also known as runaway gaps,occur in the middle of a price pattern and signal a rush of buyers or sellers who share a common belief in the underlying stock’s future direction.

To Fill or Not to Fill

When someone says a gap has been filled, this means that the price has moved back to the original pre-gap level. These fills are quite common and occur because of the following:

• Irrational exuberance: The initial spike may have been overly optimistic or pessimistic, therefore inviting a correction.
• Technical resistance: When a price moves up or down sharply, it doesn’t leave behind any support or resistance.
• Price pattern: Price patterns are used to classify gaps and can tell you if a gap will be filled or not. Exhaustion gaps are typically the most likely to be filled because they signal the end of a price trend, while continuation and breakaway gaps are significantly less likely to be filled since they are used to confirm the direction of the current trend.

When gaps are filled within the same trading day on which they occur, this is referred to as fading. For example, let’s say a company announces great earnings per share for this quarter and it gaps up at the open (meaning it opened significantly higher than its previous close). Now let’s say, as the day progresses, people realize that the cash flow statement shows some weaknesses, so they start selling. Eventually, the price hits yesterday’s close, and the gap is filled. Many day traders use this strategy during earnings season or at other times when irrational exuberance is at a high.

How to Play the Gaps

There are many ways to take advantage of these gaps, with a few strategies more popular than others. Some traders will buy when fundamental or technical factors favor a gap on the next trading day. For example, they’ll buy a stock after hours when a positive earnings report is released, hoping for a gap up on the following trading day, if it hasn’t already happened in after-hours trading. Traders might also buy or sell into highly liquid or illiquid positions at the beginning of a price movement, hoping for a good fill and a continued trend. For example, they may buy a stock when it is gapping up very quickly on low liquidity and there is no significant resistance overhead.

Some traders will fade gaps in the opposite direction once a high or low point has been determined (often through other forms of technical analysis). For example, if a stock gaps up on some speculative report, experienced traders may fade the gap by shorting the stock. Lastly, traders might buy when the price level reaches the prior support after the gap has been filled. An example of this strategy is outlined below.

Here are the key things you will want to remember when trading gaps:

• Once a stock has started to fill the gap, it will rarely stop, because there is often no immediate support or resistance.
• Exhaustion gaps and continuation gaps predict the price moving in two different directions—be sure you correctly classify the gap that you are going to play.
• Retail investors usually exhibit irrational exuberance; however, institutional investors and algorithmic systems may play along to help their portfolios, so be careful when using this indicator and wait for the price to start to break before taking a position.
• Be sure to watch the volume. High volume should be present in breakaway gaps, while low volume should occur in exhaustion gaps. 

Gap Trading Example

The daily chart of Apple Inc. (AAPL) above shows many gaps, which is quite normal given the propensity for equities to gap above or below the previous day’s price action, when the market is closed but news is still forthcoming and filtering into the market price.

Let’s take a closer look at some of the gaps that occurred. Starting from the left, we can see a bullish engulfing line, suggesting the move lower may be reversing (candlestick analysis). This is followed by a bullish gap higher, further suggesting that a low is being formed. An attempt at the downside is made again, but another large bullish engulfing line signals a low may have been made.

In the center, we see a bearish exhaustion gap, indicating that the move higher is running out of steam and may be reversing. The gap is filled relatively quickly, but it continues to act as resistance (horizontal yellow arrow), suggesting that downside potential remains. Finally, on the right side, in the midst of a reversal higher, we see a strong runaway gap indicating further upside potential.

As you can see, gaps are important price developments, leaving some in the dust and others to quick profits. At the minimum, gaps are important features of a security’s price action and should be monitored closely for potential trading opportunities.

The Bottom Line

A gap occurs when the market price of a security jumps to another price level, either higher or lower, where little if any trading has taken place. A good example is an unforeseen comment from a senior Fed official regarding the direction of interest rates. Once the comment hits the newswires, markets may react immediately, with market makers pulling their bids and offers. This may cause a price gap from the last price at $ to $, for example.

Gaps are frequently seen in price charts of almost every security. In stocks, the most frequent and significant gap occurs between the daily close and open of the exchange. In FX markets, since they operate 24 hours a day, a gap may not be visible (possibly on a one-minute chart) but instead appears as a very long candlestick covering the gap in price. (FX markets may experience gaps over the weekend, between the Friday New York close and the Sunday Asia opening.)

Price gaps can bedevil traders, especially if they’re on the wrong side of the gap. The most attractive trading opportunity with gaps is to go long or short as the market moves to close, or fill, the gap. In the example above, a reasonable trade strategy would be to buy the security that has broken higher from $, in a zone between $ and $, in case it doesn’t completely fill the gap. Should the price eventually fall back below the breakout price of $, it may suggest that the gap higher was unsustainable and that the downside remains most in play.

Forex gaps, when they occur, can offer you trading opportunities. This article focuses on the most common forex gap trading strategies.

There are many forex gap trading strategies, some being more common than others. Let's take a look at some of the most useful ones.

Gap Trading Strategy 1: Trading the fill

Trading the fill is the most common forex gap trading strategy, and it's based on the tendency of the price to fill after a gap.

Forex gaps often get filled over 60% of the time. So when you see a currency pair gapping, you can trade it by entering a position in the direction opposite to the gap. For instance, go short when the price gaps up, and buy when the price gaps down.

Place your stop loss some pips above or below a gap up or a gap down, respectively, and place your take profit at the level where the gap gets filled. However, it's better to ignore this strategy when there are really small gaps that are less than 10 pips. The reason is that the profit could be negligible when you factor in the spreads of your broker and the volatility of the currency pair.

Speaking of volatility, a gap should fill within the next 24 hours on most volatile currency pairs. This is the time to take your profit. However, sometimes the reversals from the gaps keep going on for a while, turning gaps into exhaustion gaps.

So, to help you prepare for such situations, take half of your profit off the trade and move the stop loss to break even after the price completely fills.

Gap Trading Strategy 2: Trading the gap as a support and resistance level

This is another forex gap trading strategy that's based on the filling tendencies of the forex chart. And it is also one of the many effective ways of trading support and resistance.

Quite often, you’ll find that after the price fills up and returns to the level before the gap, this level becomes a support or a resistance level, where the price further reverses from.

When exploiting this gap trading strategy, mark the level where the gap has begun. After the gap fills and the price falls back to the level you have marked, buy or sell in the direction of the gap. Place your stop loss level somewhere below the candlestick that initiated the gap. You can rely on any take-profit strategy to cash in your profits if the trade goes in your favor.

Gap Trading Strategy 3: Trading the breakout of a gap

Trading the breakout of a gap is very similar to trading the support and resistance strategy that we've mentioned above. They both rely on the tendency of a gap to form a support or resistance zone, which the price may retest. However, these two strategies focus on two different directions the price moves in, when it hits this support or resistance zone.

In the previous strategy, the price reverses from the support/resistance level. In trading the breakout of a gap strategy, however, it breaks out of the support/resistance level. These two trading strategies are the possible scenarios that could occur when the price fills up the gap and uses the same gap as a support and resistance level.

You can try out this technique using one of these effective breakout trading strategies. But the most common approach is to wait for the price to breakout out and retest the level before entering a position.

You could also trade the immediate breakout, but this may increase your risk, since the support/resistance level has not been tested yet.

Gap Trading Strategy 4: Trading the gap and go

Up untill now, the strategies we’ve discussed have all been based on the tendency of the price to fill the gap it has created. But this isn’t always the case.

Sometimes, the price gaps in one direction and just keeps following the same direction without filling up within the next 24 hours. This is exactly what has happened on the EURUSD between the last day of and the first trading day of

There are many ways to trade the Gap and Go strategy, and most of them involve combining the strategy with another forex technical trading tool. You could use a volume indicator, such as the FXSSI Better volume indicator, to determine the amount of momentum behind the gap.

You could also use the price action of candlesticks to complement this Gap and Go strategy, which is what we’ll be using in our case.

As soon as you notice the gap, read the bias and strength of the candlesticks to help you predict the potential bias of the price. In the chart above, for instance, you’ll notice that the first candlestick after the gap is a strong bullish exhaustion candle.

And although the candlestick after that is a bearish candle, the next two candlesticks are going to be strong bullish ones.

More experienced traders might have picked this out as a bullish bias, and they would have been right. But in case you haven’t, you’ll also notice that the price retests the newly formed support level twice. This is another strong bullish sign, and you should make the trade.

Tips on Trading the Gap

Keep these tips in mind as you implement the gap trading strategies:

1. Don’t assume the gap will always fill. As you might have noticed from the fourth strategy we've mentioned, the gap doesn’t always fill. So, don’t make a trade setup based on your assumption that the gap will fill.
2. Don’t trade the strategies in isolation. This could lead to wrong conclusions. But use other forex technical tools to confirm your gap trading strategy. In the Gap and Go strategy, for instance, we used forex candlestick patterns to help us predict the potential bias of the price.

Conclusion

Forex gaps do not happen very often, but they are worth trading using these strategies when they appear. And because of their scarcity, you might need to scan through a lot of currency pairs at the resumption of the forex market after the weekend to spot a gap.

However, remember that not all gaps are to be traded. Some gaps are too small. Ignore such gaps, especially if your broker imposes huge spreads.

A “gap” in the market occurs when the opening price is either higher than the previous session’s high price (gapping up), or lower than the previous session’s low price (gapping down).

An example of a gap up is shown below. Note how the last day’s open was above the previous day’s high price. The “gap” can be seen between the blue and red horizontal lines:

An example of a gap down is shown below. Note how the last day’s open was below the previous day’s low price.

Gaps can be important in trading because there is a widely held belief among traders that gaps are usually filled quite quickly, which provides an opportunity for Forex traders to make a likely profit, because the most likely short-term direction of the price can be successfully predicted.

A gap is defined as being filled when the current market price returns to enter the price range of the previous session. For example, if on Monday stock A trades between a low of $10 and a high of $11, then opens on Tuesday at $12, the gap will be “filled” when the price reaches $11 again.

It is very easy to identify a price gap visually from a price chart in your trading platform.

Forex Brokers We Recommend in Your Region

I used examples from the stock market above because price gaps happen far more frequently in stock markets than in Forex markets. This is because the Forex market is open continuously from Monday morning until Friday night, with the exception of a few major public holidays, so opportunities for gaps to occur only really happen over weekends.

In stock markets which close overnight, a price gap can happen on any day.

Some traders look for gaps in Forex markets on a daily basis by deeming trading only “open” during the business hours of the countries relevant to the currencies. I do not believe these strategies are much use, so I will not be covering that here in any detail.

The important thing to know is that in Forex, price gaps will form when the market opens in Asia on Monday morning, or after very major holidays when Forex brokers shut down their price feeds, such as Christmas Day and New Year’s Day.

Now we have established that price gaps can only really happen in Forex after a weekend, you are probably asking how often they happen. To answer this question, we should look at historical price data of the two major Forex currency pairs, EUR/USD, and USD/JPY, which together account for more than half of all Forex trading by volume. They are also the cheapest currency pairs to trade.

Between January and May , the EUR/USD currency pair produced price gaps, while the USD/JPY currency pair produced As almost all Forex price gaps occur over weekends, and as there were 1, weeks covered by the time period surveyed, we can say that a price gap is formed after the weekend about 20% of the time in Forex. This means that you are likely to see a price gap in a currency pair on average about once every five weeks.

Now we know how often price gaps tend to happen, it is worth looking at how large the gaps are before we build a gap trading system which can show us how to trade a price gap. The size of a Forex weekend price gap is measured by the distance in pips from this week’s opening price to the high of the previous week’s range, in the case of a gap up, or from the low of the previous week’s range to this week’s opening price, in the case of a gap down.

The size of the price gaps observed in the two major currency pairs are shown below:

EUR/USD

USD/JPY

We can see from this data that the vast majority (80%) of weekend price gaps in Forex have tended to be small – less than 25 pips. This fact needs to be considered when building a Forex gap trading strategy.

Now we know how often gaps tend to happen and how large they tend to be, we can ask the really important question – is it really true that gaps usually get filled?

Every gap trading strategy I ever saw relies on gaps getting filled more often than not to be profitable. So again, we need to look at what the historical data shows us.

Historical data in the EUR/USD and USD/JPY currency pairs shows that weekend gaps usually have gotten filled before Wednesday in London, i.e. within about 50 hours of the weekly open. However, the bigger the gap, the less likely it is to be filled quickly, as the data tables show below:

EUR/USD

USD/JPY

We can draw some exciting conclusions from this data that can help build a profitable gap trading strategy:

• The smaller the price gap, the more likely it was to be filled quickly.
• All price gaps in EUR/USD were more likely than not to be filled by Wednesday London time, no matter how big they were.
• Price gaps in USD/JPY were more likely than not to be filled by Wednesday London time if they were less than 75 pips wide.

One extra factor worth examining is whether trend has any effect on how likely a price gap is to be filled. For example, in a long-term upwards trend, we might expect gaps down to be even more likely to be filled. Conversely, in a long-term downwards trend, we might expect gaps up to be more likely to be filled.

We can measure the effect of trend simply and effectively by saying that if the price is higher than it was three months ago, there is a long-term upwards trend; if lower than it was three months ago, there is a long-term downwards trend.

Repeating the analysis by only including gaps that could be filled by movement in line with the trend produces the following historical results:

EUR/USD

USD/JPY

It is clear from this data that weekend price gaps which can be filled in the direction of the trend, as measured by whether the price is higher or lower than it was three months ago, are considerably more likely to be filled by Wednesday than gaps which need to be filled against the trend.

Identifying weekend price gaps in Forex currency pairs and entering trades which aim for the gap to be filled before the end of Tuesday, has historically been a very simple and profitable trading strategy. This strategy can be traded using only the weekly time frame.

Price gaps in the EUR/USD and USD/CHF currency pairs are usually filled quickly. Price gaps in other currency pairs are usually filled quickly if the gap is less than 75 pips in size.

The probability that a weekend price gap will be filled quickly is even stronger when the predicted fill is in the direction of the long-term trend.

This tendency of weekend price gaps to fill in Forex can be exploited simply by entering a trade as soon as the new week opens with the formation of a gap. Take profit should be set for the previous week’s range, while the stop loss should never be larger than the amount of pips targeted by the take profit level.

An alternative method to use within a forex gap trading strategy is to watch the price action on shorter time frames, and then enter a trade in the direction of the fill using a tighter stop loss once the price action indicates a move is likely underway.

How do you trade gaps in the market?

You trade gaps in the market by expecting that they will be filled, entering an order in the direction of the anticipated fill while making sure your stop loss is never larger than your take profit target.

What is a gap fill in trading?

A gap is filled when the price returns to enter the price range of the previous session. For example, if yesterday the price ranged between $10 and $11 but opened today at $12, the gap is filled once the price falls at least as low as $

As the forex market operates continuously throughout the week, the closure during the weekend can result in a discrepancy between the closing price on Friday and the opening price on Sunday. Below we delve into the dynamics of the weekend gap trading strategy in forex, a tactic that many traders utilize to harness profit from this particular market characteristic.

Defining Weekend Gaps

Forex trading is known for its 24/5 activity, following the business hours of the world's major financial centers. At the end of the New York trading session on Friday, the forex market draws to a close and only reopens with the Sydney session on Monday. During this time, currency prices are susceptible to change due to many factors, such as emerging geopolitical events, newly-released economic data, or other significant news that can move the markets. When the trading resumes, if the opening price differs markedly from Friday's closing price, a "gap" is said to have occurred.

The Theory Behind Weekend Gap Trading Strategy

The weekend gap trading strategy has gained traction among forex traders eager to capitalize on these price discrepancies. The primary premise of this strategy is the market's propensity to attempt to fill the gap, meaning that the price will endeavor to return to the Friday closing point. Therefore, traders strive to initiate positions as soon as the market opens on Sunday, banking on the price reversal to close the gap.

Executing Weekend Gap Trades

To proficiently trade weekend gaps, there are several vital steps to consider:

Identify the Gap

The first task at the market opening on Sunday is to ascertain whether a substantial gap has formed between the closing price on Friday and the opening price on Sunday.

Initiate the Trade

If a gap exists, the next step is to place a trade in the direction that anticipates closing the gap. For instance, if the opening price on Sunday is higher than the closing price on Friday (an upward gap), a short position would be the appropriate move, predicting a decline in the price to close the gap.

Timing is vital, as entering too early will likely result in a loss. An opening gap will initially result in some traders who held positions on Friday needing to exit with a loss. To profitably trade this pattern, wait until the stop loss orders are finished to enter a position. If the market suddenly moves in one direction and then quickly starts to move in the reverse, it could be a sign that the stop loss orders are finished and a good entry point.

Determine Stop Loss and Take Profit Points

A simple risk management strategy is to set your stop loss below the opening of the Monday price and a target at Friday's close. More advanced traders will use trailing stops to reduce risk and look for opportunities to extend profits should the market return to Friday's close.

Supervise the Trade

After placing the trade, it's vital to monitor it closely. Depending on the market's volatility, gaps can close quickly or gradually. Sometimes, the gap may not close during the upcoming trading week, and this can lead to significant losses if you do not exercise caution, as many other traders will be stuck with a similar losing position.

Risks of Gap Trading

While weekend gap trading can present lucrative opportunities, it is crucial to be mindful of the associated risks:

Non-Closing Gaps

Not all gaps close. Some gaps linger open for an extended period, leading to drawn-out periods of negative return. Do not assume all gaps will close. Weekend news events can be important and start new price trends which can continue for a long time.

Slippage

The forex market can exhibit considerable volatility during the opening on Monday. Slippage can occur, meaning your orders may be executed at a different level than you've set. Be patient with your entry point and avoid chasing the market.

Risk of Wide Gaps

Over the weekend, major events or news releases can trigger unusually wide gaps, which might exceed your risk tolerance. Wait until the market calms down to reduce your risk.

Integrating Risk Management in Gap Trading

Incorporating effective risk management techniques is a crucial aspect of weekend gap trading. Here are some ways to safeguard your trading activities:

Risk Per Trade

Each trade should only risk a small fraction of your trading capital, typically no more than %.

Correlation Risk

If you're trading gaps on several currency pairs that are closely correlated, you should be aware of the correlation risk.

News Awareness

Stay updated about significant news events over the weekend that could catalyze extensive gaps. News analysis can be complicated as analysts will have varying views on the importance of an event but never underestimate the power of market news on Forex prices.

Backtesting and Demo Trading Your Gap Trading Strategy

It is essential to test any new strategy before implementation. Begin by backtesting the gap trading strategy against historical data, and then practice it in a demo account to observe how it performs under real-time market conditions. This will allow you to assess its effectiveness and adjust based on your observations.

The Psychology of Gap Trading

A less discussed but equally important aspect of gap trading is trader psychology. It requires patience to wait for the market to open and see if a gap forms. Emotional control is crucial once a trade is initiated, as the price may move against you before the gap starts to close. Sticking to your predetermined stop loss and taking profit without succumbing to fear or greed can often be the difference between success and failure in gap trading.

Conclusion

Weekend gap trading is a potentially very profitable strategy that capitalizes on the pause in the forex market. While it can offer substantial profits, it's crucial to understand the associated risks and employ effective risk management strategies.