Courses on forex: Gap Trading

Courses on forex: Gap Trading

In courses on forex, gap trading is an important concept. This article explores what a “gaps” actually are, how and when they occur and how their existence provides trading opportunities.

A gap occurs when the opening price of a candlestick is higher or lower than any point in the range of prices covered by the immediately previous candlestick. The two candlesticks involved must be on the same timescale. A gap could be small and therefore show only on the 1 minute candlestick chart or large in which case it may occur on several consecutively larger candlestick charts up to a timescale which encompasses and does not show the gap.

forex price chart Gap exampleHere is an example of a gap that occurred and showed up on the 1 minute, 5 minute and 15 minute candlestick charts. This was a “gap up” which means that the second candlestick covered a range of prices which were all higher than the prices covered by the first candlestick. Had the second candlestick had a price range below that of the first candlestick we would be looking at a “gap down”.

The chart shown is a 15 minute chart so the gap would have also shown up on the 1 minute and 5 minute chart and it would have appeared even more dramatic on those charts while not being visible at all on say a 1 day chart.

Why do gaps occur?

Gaps do not happen frequently and we may go for many weeks without one occurring. The market “does not like” gaps. However, they do occur and generally there will be one of two reasons behind the gap.

Price gaps caused by scheduled news events

The first reason is scheduled news, news can move the market and sometimes it can move it dramatically enough to create a gap. To create a gap news normally has to be significant and usually significantly different from what has been forecast by most traders and analysts.

News normally comes in two varieties. The first is scheduled news such as the announcement of a change in interest rates, unemployed numbers or one of several other such regular announcements. The gap shown came as a result of a scheduled news announcement. The currency pair represented on the chart is the GBPUSD and the date of the screen shot being taken was 25th April 2013 and the gap occurred at 9.30 am.

The news which caused the gap to occur was the announcement of movement in the UK’s Gross Domestic Product (GDP) for the three month quarter ending on the 31st of March 2013. The forecasters had expected a change of +0.1%. This number itself was significant as a negative outcome would have formally placed the UK in recession for the third time since the financial crisis representing a “triple dip” recession which has never been recorded.

The actual result announced at 9.30 was + 0.3%. While this is far from a brilliant result it was far enough away from expectations to cause a gap up.

Each scheduled news event has a track record of affecting the market if actual outcomes are significantly different from forecast. Most news announcements do not move the market almost irrespectively of what is announced. However, the UK’s GDP has a record of making the market move by at least 50 Pips if the actual differs from the forecast by +/- 0.2% which, of course it did on this occasion. The fact that the result made such an important difference to whether or not a triple dip recession had occurred was enough to make the price move significantly and to actually gap up.

Gaps caused by unscheduled news events

History is littered with major events that have caused the market to gap up or to gap down. A few of these will provide a flavour of the type of unscheduled news event that can cause the markets to move substantially and quickly enough to cause a gap. They are; the 9/11 twin towers attack, commencement of the first war in Iraq, the death of Osama Bin Laden.

Osama Bin Laden died on May 2nd 2011. This was not imminently expected news and it caused the USD to increase in value to such an extent and suddenly enough to cause a gap.

There are many other examples of gaps occurring on less significant unscheduled news events.

Example of unscheduled news causing price gap death of Osama Bin Ladan

Osama Bin Laden – his death caused a forex price gap

Gaps caused by the passage of time

When the market is closed prices continue to move albeit unseen. News continues to happen, demand builds, volume stores up. At least some of the movement in prices that would have happened had the market been open will still occur. Therefore, it can be expected that the price on re-opening will be different from what it was when the market closed and a gap is fairly likely to occur. This happens during public holidays and on many Sunday evenings at 10.00 pm (UK) after the market has been closed for 48 hours since 10.00 pm on the previous Friday evening.

Why not a gap every Sunday night?

If our contention is that the passage of time while the market is open causes gaps to occur; then why don’t we see a gap every Sunday night?

The answer is that there is a gap every Sunday night when the market opens – we just don’t get to see all of them or even the whole of most of those that we do get to see. The reason for this is that the professionals, banks etc. have an earlier opening time than us “poor old” retail traders. By the time the market opens for us the gap has either closed or has significantly reduced. The professionals have a 2 hour start on us and it is therefore a wonder that we see any gaps at all when the market opens.

How can gaps help us?

Most, but definitely not all, gaps that open are closed within a relatively short period – often within a few minutes and usually within a few days. Therefore, if everything else looks right a trade that anticipates the closure of the gap can be a good idea. Remember, the market does not like gaps and will try to close them if it can.

Example of price gap closingHere is an example of a gap opening and then closing. This is a 1 minute chart and it took 37 minutes for the gap to close. The trend was actually downwards either side of the period shown.

About The Author

Jeff Fitzpatrick

Probably the UK's most successful home Forex trader