At times it is common to see candlesticks or bars starting to form away from the close of the previous candlestick or bar. For instance, a candlestick may close at 1.23456 on EURUSD and instead of the next candlestick opening at 1.23456, it opens at 1.75432. There will be a gap between the two candlesticks and this is the gap we are referring to. The market may gap down or upwards depending on the prevailing market circumstances.
In most cases, gaps are witnessed at the start of the week after the brokers resume. It is mainly as a result of market activities which have occurred during the weekend and were not captured on the market charts. There is a myth which is always circulating that all gaps always gets filled. However, it is very important to know the type of gap so as to be able to predict whether the gap will get filled any time soon or it will take months or it will even never get filled. By a gap getting filled, we mean that the candlesticks or bars will form back to through the gap. For instance if the markets had gapped up, the markets prices tend to move down till they get to the price at which the previous candlestick before the gap had closed. For example, if the price before a gap was 1.56734 and after the gap the next candlestick starts at 1.8976, the market could take the whole of the next week or even just a couple of hours or even days, moving down till the prices touch 1.56734 again.
Types of gaps
There are four major types of gaps that do occur. Each of these gaps tend to reflect some market conditions and a trader should identify which type of gap just occurred so as to be able to understand what is happening to the market and even be able to make the right decision on how he/ she will trade the gap. These gaps are include:
- Common gaps
Common gaps are those gaps which cannot be placed into any kind of pattern. The market just gaps. This are in most cases witnessed on Mondays when most brokers resume. These gaps are usually small and in most cases gets filled up very quickly. Actually, they are even hardly noticed unless a trader is very keen to observe immediately the broker resumes after the weekend break. This are therefore the best gaps to trade. To trade the common gap, you simply have to wait for midnight when the broker is resuming and not if there are any gaps especially in the most liquid currency pairs like EURUSD, NZDUSD, GBPUSD, USDCAD or USDCHF. Also confirm that there are no major occurrences in the respective countries that would have resulted to a disruption of their respective economies in a way that the values of their currencies could be affected. Any such occurrence would be a cause of a different type of a gap and this would not be a common gap. To determine whether the gap is filling, simply look at the prevailing market trend or the nature of candlestick that forms immediately after the gap. If the candlestick is towards filling the gap then there is a likelihood of the market filling the gap. You should place a trade at the price after the gap and set the target (take profit) at the close of the candlestick before the gap occurred. You can also choose to place a stop loss at same distance.
- Breakaway gaps
This gaps normally occur at the end of a trend. They signal the start of another trend. To identify these types of gaps, look for consolidation. If a gap takes place after a market consolidation, then rest assured that you are looking at a breakaway gap. Such gaps are hardly filled and you should avoid trading to fill the gap. Rather trade in the direction of the gap. If it was an upward gap, you should place a buy since it indicates the onset of a bullish trend. If it was a downward gap, then you should place a sell since it indicates the onset of a bearish trend.
- Continuation gaps
This are gaps are also referred to as runaway gaps. They form in the same direction of a trend. The market tends to have received a catapulting force which makes it to make a leap in the same direction. When such a gap occurs, the markets in most cases first retrace back to cover the gap before continuing with the trend. However, you should be careful since you may be late and the market trend could just be continuing.
- Exhaustion gaps
This normally occur when the trend is nearing its end. It is usually a final attempt of the markets to hit a high or a low that seems to delay to get to. The market prices kind of jump to get to those highs or lows. To identify exhaustion gaps, you should use trend indicators so as to determine whether the market trend is almost ending. Signs of an ending trend include market consolidation and also oversold or overbought characteristics.