Exploiting Opening Gaps in FX Trading
02/26/2013 6:00 am EST
Even though opening gaps rarely occur in the forex market, it is well worth it to be on a lookout for them, writes Mike Kulej of FXMadness.com, as they create good trading opportunities.
In most financial markets, gaps are important events and many trading concepts are built around them. We all heard about "continuation gaps" and "exhaustion gaps," as they are featured prominently in literature on technical analysis. Even many candlestick patterns, as originally developed, include the concept of price gaps. For example, the "abandoned baby," the "hammer," or the "hanging man" should have a gap on one side (or both) when applied on daily or weekly charts.
Unfortunately for forex traders, gaps are relatively rare. Due to the 24-nature of this market, the trading is continuous, thus not creating gaps. In the past years, currency futures provided a venue for this phenomenon, but that is no longer the case. These days even these instruments have extended sessions and the seamless environment simply eliminated trading gaps. The only time when these features form in forex is when the markets open after a weekend or a holiday. Of course, they do not always develop, but in those instances when the opening is dynamic, the gaps create good trading opportunities. Yesterday was a very good example of that.
In the last post, I mentioned the possibility of strong opening in the GBP pairs, potentially producing gaps. Indeed, they moved sharply lower at the start of trading, with large breaks between Friday's close and Monday's open. The price started to move back immediately, and I decided to play the gap with a buy order above the first discernible minor high. In case of the GBP/USD, that translated to entry at 1.5095, using 1M chart.
Under most circumstances, I would have looked at 5M charts, but the volatility was high enough to try even the smaller time frame. My objective was about 1.5145, not quite closing the gap, but trying to capture most of it. After all, the precise closing levels may vary slightly from platform to platform, so calculating objective to the pip could be foolish. In this case, the volatility evaporated at around 1.5137 and I decide to close the trade. The 39 pips profit covered most of the gap and were made in a relatively easy way. No need to be greedy.
Other promising gaps formed in the yen pairs. Since I discussed the AUD/JPY yesterday, albeit in a different context, I also placed a trade here. My interest is only in shorting these instruments, so the upside gaps fit into the overall strategy. The AUD/JPY started to retreat right away, forming a good entry at 96.84. In this example, my target was at 96.54, also short of a complete "fill."
This also turned out to be a good transaction, quickly making the intended 30 pips. Even though opening gaps do not form after every weekend, it is well worth it to be on a lookout for them. It takes very little effort to spot them-one glance at the appointed hour. However, if the gaps are not filled quickly (within one trading day), there is no telling how long they will last. Just look at daily charts of the yen crosses, with gaps from late December remaining. I still intend to keep shorting these pairs and hopefully see those gaps closed.
By Mike Kulej of FXMadness.com