Typically, the Forex market is quite volatile and it’s this volatility that can cause gaps. Today, we’re going to go into why gaps are well worth paying attention to.
So, why are gaps are important?
To put it simply, gaps can give us an idea of support and resistance levels, especially when they occur near existing or previous significant levels. When they occur at significant previous levels, we call this confluence. And as you may well know, when there’s confluence at a particular level, the more likely it is that the level will hold. This factor, when used in conjunction with a price action strategy results in a winning combo.
What’s A Gap?
There’s nothing really complicated about gaps on a Forex chart, but the best way to show what they are is to bring up a chart.
You’ll notice that the major gaps are highlighted green, and whilst there are a few others that aren’t highlighted, this should outline quite simply what a gap is. A gap is simply a difference in the closing price of one candle and the opening price of the candle that immediately follows.
Why Do These Gaps Form?
First, let’s clear something up. The Forex market never closes. It doesn’t close on weekends, nor does it close on holidays. It’s only closed to us retail traders on weekends, but aside from that, it’s alive and well.
Now here’s another fact that’ll bamboozle you… gaps don’t really exist. Well, at least not in the market. In reality, it’s your broker who’s responsible for the gaps you see in a chart.
When retail trading is closed for the weekend, your broker doesn’t allow you to trade. Even though the market is alive and well, your broker finishes displaying prices at 5pm EST on Fridays. The Forex market is still moving over the weekend, and then come Monday when your broker fires up again, there’s a visible difference in the closing price of Friday’s candle and the open price of Monday’s. Thus, you see a gap on your chart.
What Can You Do With These Gaps?
Let’s now go over how these gaps can be traded. First and foremost, gaps can be used to identify key support and resistance levels in the Forex market. As traders, success can be greatly dependent on our ability to identify significant levels that have a decent probability of producing a reaction in price.
As discussed earlier, the best gap trading opportunities occur when they coincide with significant previous price levels. So we ideally want to see confluence, or, more than one reason as to why a level is significant – in the below instance, we see an example of a gap occurring at previous support and resistance levels.
Notice in the above chart that there is a well-defined key level, which is made even more significant by the multiple gaps occurring at previous highs. This level once broken through then acts as significant resistance at the first yellow circle. Traders could look to buy into this area on the slight retrace as it has now become a strong support level.
Awareness of these gaps and their significance, especially when they occur at previous levels is a powerful asset for any price action trader, across any trading instrument. This confluence provides a solid edge at established previous levels which puts the odds in your favour.
As always, longer timeframes should be treated with more credibility. Larger gaps on higher timeframes offer more statistical probability than on short-term timeframes, and are more likely to produce a change in direction.
Next time you’ve got a chart up, take note of any obvious gaps, they just might offer you a decent trading opportunity.
Source: Vantage FX Blog