What is a Gap in Forex Trading?
A “gap” in financial markets refers to the significant difference between the closing price of candlesticks or a bar and the opening price of the following bar or candle. These gaps often arise when market fundamentals experience a notable shift due to news events, especially during hours when markets are typically closed, such as an after-hours earnings call. In this article, we will explore what is Gap in Forex Trading and the four main types.
What Does a Gap Symbolise in the Forex Market:
A gap occurs when a news or event in the market causes a ton of buyers or sellers into the market. It results in prices in the market opening higher or lower than the previous day’s price.
Here are 4 Main Different Types of Forex Gaps:
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Common Gap:
A common gap is a gap that frequently occurs in the market. They mostly occur in small sizes due to price fluctuation and most often they get filled relatively quickly. These gaps mostly do not influence change in market trends but rather they reflect on the market flow of activity. Common gaps are commonly known as “Area Gaps” or “Trading Gaps” and are accompanied by everyday normal average trading.
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Breakaway Gap:
Breakaway gaps stand out as more consequential and more profound in the forex market. Breakaway gaps are one of the key terminologies in technical analysis. A gap occurs when there is a disparity between the opening price and the previous closing price, indicating a lack of trading activity. Unlike an intraday breakout, a gap signifies the price’s departure from a support or resistance level. Breakaway gaps commonly appear at the start of a trend, marking the price’s exit from a trading range or signalling a shift in the prevailing trend.
A breakaway gap materialises when the price abruptly surges above a previously established support or resistance level, often found within a trading range. This gap type denotes a significant departure from the confines of a well-defined trading range. It is important to note that breakaway gaps can originate not only from trading ranges but also from various chart patterns such as triangles, wedges, cup and handle formations, rounded bottoms or tops, and head and shoulders patterns.
These gaps typically serve as confirmations of a new trend. For instance, if the preceding trend were downward, and the price forms a substantial cup and handle pattern, a breakaway gap appearing above the handle could validate the end of the downtrend and the commencement of an upward trend. In such instances, the breakaway gap, indicating strong buyer conviction, acts as a convincing indicator signalling further upward potential, especially when coupled with the breakout from the chart pattern.
The strength of a breakaway gap often correlates with the accompanying trading volume. A breakaway gap supported by higher-than-average or notably elevated volume strengthens the conviction behind the gap’s direction. A surge in volume during a breakout gap substantiates the likelihood of continued price movement in the breakout direction. Conversely, if the volume remains low during a breakaway gap, it increases the probability of a failed breakout. A failed breakout occurs when the price briefly breaches resistance or support levels but fails to maintain the movement and retreats into the prior trading range.
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Runaway Gaps (Continuation Gap)
Also known as a continuation gap, the runaway gap, commonly observed on charts, manifests when trading activity bypasses consecutive price levels, often propelled by significant investor enthusiasm. This gap represents a lack of trading—where there was no exchange of ownership in a security—between the initial and final points where the runaway gap occurred.
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Exhaustion Gaps:
An exhaustion gap is a technical indication observed as a downward break in prices, typically seen on a daily chart. This occurrence follows a rapid ascent in a currency pair’s value over several weeks.
This signal represents a notable transition from buying to selling activity, coinciding with diminishing demand for the currency pair. Its implication suggests a potential conclusion of an ongoing uptrend.
Exhaustion gaps tend to emerge near the conclusion of a trend, signifying a potential halt in the price movement. These gaps commonly surface after a prolonged trend and often precede a reversal in the market’s direction. They potentially indicate a decline in the prevailing trend’s momentum.
In Conclusion
In conclusion, gaps in forex trading act as vital indicators of shifts in market sentiment and potential trend developments. Discerning between various gap types and understanding their implications empowers traders to navigate the intricacies of the forex market more effectively. This comprehension enhances their capacity to pinpoint trading prospects and manage risks more astutely.
However, despite their significance, gaps come with limitations. While they are easily identifiable, correctly interpreting the different gap types is crucial. Misinterpreting a gap could lead to a critical mistake, causing traders to overlook opportunities either to buy or sell a security. Such misjudgements can significantly impact profits and losses, underscoring the importance of accurate gap analysis in forex trading strategies. Hence, while gaps offer valuable insights, prudent analysis and understanding of their nuances are essential for informed decision-making in the dynamic forex market.
