Here is a very simple trading strategy, which happens often enough to be exploitable. It has to do with gaps on the open after the weekend.Most trading is done using some type of technical analysis. There is an almost infinite number of indicators which can be used in myriad of ways. Trend lines, retracement levels, Fibonacci numbers, Elliot wave analysis, candlestick patterns, point and figure charting are also widely used. Just about any form of technical analysis can be used for trading Forex. Yet there is a trading application popular in other in other financial markets that is not widely used in currency trading – price gaps.There are couple of reasons for that. Forex is a 24 H market, therefore markets don’t stop, providing continues stream of price quotes. Even during important fundamental announcements, when it is possible for price to move substantially, creating gap, it would only be visible on tick charts and hidden on any larger magnitude graphs. Most traders wouldn’t even notice it, making it useless for any practical approach. Also, Forex market is the most liquid and deep of all financial markets. This means that just at about any price level there are enough buyers and sellers to make price gaps almost impossible to form.
The only time when gap analysis and trading is of any value happens at the start of a trading week. Typical retail platform closes at 17:00 EST on Friday and opens at 17:00 EST Sunday. Some banks start trading 3 or even 4 hours earlier, which might create price gap when platforms open for trading. Also, heavy order build up on one side will create sudden price shift, a gap. In most instances these events can be exploited.
Most of the time these gaps are filled within 4-8 hours. If the gap is to the downside, one can establish a buy position and hold it until the price fills the empty spot. It is not advisable to chose an arbitrary buy point, but rather look for shorter term reversal signs on 5M or 15M chart. Also, the target should not be the absolute width of the gap, but rather a point about 2/3 into the gap. For example, if GBP-USD closed on Friday at 1.6200 and opened on Sunday at at 1.6140, we wouldn’t try squeeze every possible pip, but rather settle for an objective around 1.6180. This vastly improves success rate.
Another trading strategy is “fading the gap”. This means, that as the gap is filled, we are looking for a trade in opposite direction. Using the GBP-USD example from above, we would try to sell it when the price is inside the gap. Here also the 2/3 rule applies- our sell order would not be placed at at 1.6200 but rather 1.6180 or so. Target for this trade would be an area of the low formed before this gap was filled. This technique is even easier to use than the first one.
Few additional rules are helpful when qualifying gap for a trade. Small ones are not good candidates for trading. This will vary form currency to currency, but anything under 20 pips will be better left alone. We are looking for 40+ pips in difference. Gaps not filled within 24 Hours are no longer considered for “fading” trade. Statistically, price tends to keep on going rather than reverse in this situation. Perhaps most importantly- confirm gap existence on at least one more platform. Once it is confirmed on another charting server, chances for successful trade are greatly enhanced.
Mike K.
Can you demonstrate how it works on a live example? I mean, when do you choose to enter? think this would be helpfull.
I can’t really keep updating it as it happens, because I update the blog once a day. I will try, however make multiple snapshots of how potential trade unfolds and then post them.
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