Let’s talk about something that few new traders really understand in terms of how to profit from them but instead fear them as the dreaded “stop loss killer”. Market price gaps!
Almost everyone will have seen and noticed gaps in the market price of the instruments they trade as they occur quite frequently and more commonly at the opening of market trading hours. The main reason for gaps in market price occurring is when price moves quickly and there is no buying on selling in between the previous price and the new price. Therefore you will see a clear area between the open and close of two candlesticks of a given time period.
Gaps in market price, or at least gaps of a significance, are less common in more liquid markets such as the FX markets but on stocks and some commodities you will quite often see gaps in market price. This is due to the volume of trading on the various different markets meaning there is more likely to be buyers and sellers at all levels and therefore eliminating gaps. The most common time you will see gaps in market price appear on almost all financial markets is on the open of a new trading week. This is Sunday night at 10pm GMT for the FX markets and Monday morning at 8am for the London Stock Exchange. You will more than likely see gaps of various sizes appear at these times because the markets have been closed for the 2 days of the weekend and various news and changes in sentiment will have caused price to move in premarket trading. When the markets open, price will be reflected at its new value and if this is different from the market close price on Friday then you will see a gap.
Anyway, that’s enough of the theory behind gaps… let’s look at how to make some money from them appearing! Yes, gaps in the market can mean your stop losses and risk management tools may become ineffective but this can almost be entirely avoided by carefully selecting where and when you enter trades. Gaps in market price also provide very good and profitable entries for trades to capitalise on the temporary “inefficiency” of a market.
Over the weekend (Saturday 2nd, Sunday 3rd March 2019) it appeared that the GBP FX currency appreciated in price significantly enough for me to see that a gap in market price would almost definitely appear at the opening of the FX market on Sunday night. I normally always check the premarket trading prices of any major FX currencies that are on my watchlist and GBP/USD was showing premarket prices upwards of 50 pips higher than the market close price on Friday. So immediately I was interested.
Now let’s look at what happened at the market open at 10pm on Sunday. I will show you in the 15min TF so you can see the gap more clearly.
Now let me clear something up, although I said trading gaps can be profitable and they appear quite often on certain markets, it DOES NOT mean that you should trade every single gap that appears. Unfortunately life isn’t that simple and trading isn’t that easy… I know – how annoying right? There are a few rules I use when trading gaps in market price and those rules are what makes me profitable in the long term when trading them. I won’t explain these rules in this blog post because a) they are like my KFC secret recipe and b) I don’t have time today as I want to play golf later.
What I will do in this blog is show you my analysis on this GBPUSD gap trade which takes all of 30 seconds if you are good at using your trading platform. This analysis forms part of my rules and makes sure that my strike rate on trading gaps is above 80%. Below is the GBPUSD 15min chart with a few bits of extra analysis and the market entry price that was filled.
I didn’t need all the markings on the chart to enter the trade myself but by simply identifying the current timeframes trend, Fibonacci levels, stop loss size and potential targets, I created a trade set up with attractive Reward:Risk ratio of up to 4.8:1.
As it stands I am still holding this short position on GBPUSD as there was enough momentum to close below the close price on Friday after the gap was filled. Price is now approaching target 2 at the Fibonacci 0.27 extension level. I have removed exposure from this trade to make sure that at worst I do not lose any trading capital. The chart below is this trade as at 10:30am on Tuesday 5th March.
Let’s see how it goes! You can follow this trade via my TradingView profile.
If you want to learn more about the rules I use when trading gaps in market price then please send me a message through my “Contact Me” page by clicking here.
DISCLAIMER: None of the information in this blog post is to be considered investment/financial advice. Trading is high risk and you should only trade with money you can afford to lose.