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Short Term Forex Strategies – Gaps

Short Term Forex Strategies – Gaps

There are several forex strategies that you can use to trade on the forex market.  One of the short term strategies you can use is gaps.  Gaps are those areas on a chart where the currency price moves up or down with no obvious trading between the two points.  The chart will show a ‘gap’ in the price pattern.  It is possible for the trader to use this to his or her advantage.

What are Gaps?

Gaps happen when there are underlying technical or fundamental factors involved.  An example here is if a corporation experiences much higher earnings than were expected, its stock price may increase the next morning.  This shows an increase in the opening price compared to the closing price which leaves a ‘gap’.

When this happens in the foreign exchange market, a report generates a huge amount of hype to the extent that the spread between bid and ask is widened to a point where a distinct gap is visible.  Gaps normally fall into four groups:

  • Common gaps do not appear in a normal price pattern.  It simply appears where the price has created a gap
  • Breakaway gaps occur when a price pattern has come to an end and is an indication of the commencement of a new trend
  • Exhaustion gaps normally appear when a price pattern nears its end and is a signal of one final throw at hitting a new low or high
  • Continuation gaps are common in the middle of a price pattern and is a signal of buyer or seller rush who believe that there is a specific direction in the future of the currency

Fill

When it is stated that the gap has filled, it indicates that the price has shifted back to its pre-gap point.  This happens quite often and can be due to:

  • Technical resistance causes the price to move sharply up or down and it does not leave any support or resistance behind.
  • Price patterns which have been used to classify the gaps.  The same price patterns could give you an indication if that gap is likely to be filled or not.  Exhaustion gaps are the ones that will most likely be filled because they are formed at the end of the price trend.  Breakaway and continuation gaps are less likely to experience filling as they normally confirm the direction the current trend is taking.
  • The initial upward curve was particularly pessimistic or optimistic and the gap was a mere correction of that situation.

When these gaps are filled during one trading period it is called fading.  Day traders often use this strategy when exuberance is at a high or during high earning periods.  There are several ways to take advantage of gaps.

Playing the Gaps in Forex Strategies

Traders often take advantage of this situation by buying or selling at high liquidity hoping that there will be a fill and the trend will continue.  An example is that they purchase a currency at the point when it is forming a gap with low liquidity and no overhead resistance.

You should keep an eye on volume.  High volumes will occur in breakaway gaps, with low volume in exhaustion gaps.

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