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 “Gaps” Create Trading Opportunities When They Occur

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“Gaps” Create Trading Opportunities When They Occur Empty
PostSubject: “Gaps” Create Trading Opportunities When They Occur   “Gaps” Create Trading Opportunities When They Occur Icon_minitimeFri Dec 25, 2015 5:41 am

The Following Commentary is from Tom Cleveland of

Veteran traders know from experience that the key to winning in the Forex market, or for any other market, for that matter, is recognizing profitable opportunities before they are about to happen. Over time, they develop an historical database of patterns and shapes that signal a high probability trade, one greater than 60%, is setting up. They may use technical indicators, Fibonacci ratios, or support and resistance levels to confirm their intuitive judgment, but the eye must first behold the visual “bellwether”. An opening “gap” in a market is often a free gift, so to speak, and a special situation to follow for gain.

All financial markets have an open and a close, the latter necessary for traders to catch their breath and for off-line accounting to take place. Of all the markets, however, the Forex market is the one that gets the least sleep of them all, opening on Sunday afternoon in Asia and closing Friday afternoon in New York. When markets are closed, strange things can happen. Publicity department executives learned long ago to release bad information on Friday, after markets close, knowing that most of the public will miss the news. Rumors are often hyped on weekends, too, well before traders can react.

After a significant weekend event occurs, the subsequent market open can be bedlam. Traders rush to open or close positions. A market “gap” in valuations is the result, a pronounced difference in the previous closing price and the new opening figure. The “gap” can be attributed to an overreaction by the market to the event at hand, but the occurrence offers all traders not one, but two opportunities to leverage for advantage. Here is a recent example that took place with the “USD/JPY” currency pair:

“Gaps” Create Trading Opportunities When They Occur Forex_Example_USDJPY-1024x832

Over the weekend in question, Larry Summers withdrew his name from consideration for succeeding Ben Bernanke as chairman of the U.S. Federal Reserve. The market regarded Mr. Summers as more “hawkish” when it came to using prolonged qualitative easing policies to stimulate the economy. Other contenders were considered “dovish”, meaning that current easing programs would continue, thereby keeping the USD weaker than expected. Market analysts had already assumed that the Fed would taper its daily bond purchases in the market in September. A reversal would require a market reaction.

This fundamental event resulted in the opening “gap” illustrated in the above chart. From past experiences, veterans can count on the market returning and “filling the gap”, i.e., diffusing the overreaction in order to reassess the impact of the news. In this case, the “Fill” occurred over the next two trading days, but, once again, veterans have learned to anticipate that the market will repeat the behavior that led to the gap in the first place. Trading this slide in the opposite direction is known as “Fading the Fill”.

Are there other tips that should be taken into consideration? The size of the gap in this case was roughly 100 pips, sizable, but not gigantic. The gap size will often define support and resistance for the next few days, as was the case here. If the gap follows a long prevailing trend in the same direction, then market sentiment may be formidable in that direction, and a “fill” may not be in the cards. You would want to go with the flow under that circumstance. As for the “USD/JPY” pair, it had already reversed from a few months of strengthening, but the market was uncertain as to the next move.

Gaps and Fills may come and go, but always remember: Past behavior is no guarantee of future performance. Good Luck!

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