*Market close gap trading loss and how you could avoid it happening again*
A lot of you will know that I am a big fan of trading price gaps in the financial markets as I believe they offer a really quick and simple trading strategy. Trading market close gaps is a way to take advantage of a basic “pricing error” that occurs when the market value of a commodity or currency has moved when the markets have been closed and therefore it jumps or “gaps” upon the opening of the markets.
I am still in the process of writing a full strategy guide to teach you how to trade gaps in the financial markets and this will be released as soon as possible. It is taking me longer than expected as I am filling it with as many trade examples and as much data as possible.
The process of trading market gaps is to profit from the underlying facts (as proven by backtesting data) that the majority of market gaps are filled in the following trading sessions. Therefore, with a simple 1:1 reward:risk set up, you can profit from trading these gaps in the long term. However… the key words in that last sentence are “long term”. Not all gaps are filled and therefore you will lose trades – fact!
I will talk you through the last 2 market gap set ups I saw and you will see that not all gap trades are guaranteed to be winners.
Market Close Gap Trade 1 – GBPJPY 05/05/2019
This first example is a perfect gap trade set up going with the current trend of the market. From experience these are normally (but not always) the best market close gap trades to enter because the price has gapped down in to a bullish trend and therefore when you go long you are buying the dips and trading with the trend.
I have marked on the chart above, the higher highs and higher lows of the current timeframe trend prior to the market gap and as you can see, the gap down on Sunday evening effectively gives a discounted entry to go long. My long position entry with stop loss and profit target is marked on the chart below.
This position is using my standard gap trading rules and I am aiming for the 97 pip gap to be fulfilled with a R:R ratio of 1:1. In my experience, a 97 pip gap is quite large compared to the normal market close gaps you will see on Sunday evenings when the FX markets open. As always though, I stick to my strategy and keep the trade at 1:1 R:R.
Let’s look at how it played out overnight.
Price almost immediately started to climb and close the weekend gap down but when it got to almost exactly 50% of the way it reversed and proceeded to then drop until the stop loss order was hit. As I explained earlier, the key to successfully trading market gaps is to manage your risk and “play the odds” over the longest period of time possible. You will get losing trades where price does not make its way back to the Friday market close price and fulfilled the gap.
In this example I believe there was a way to avoid the loss due to the large size of the gap down. A trailing stop loss of 50 pips would have allowed for a R:R ratio of 2:1 if the trade was successful but it would have also meant that at the point that price reversed, without fulfilling the market gap, the stop loss would be sat at your entry price and the trade would have ended net risk free.
I talk more about these rules and “tricks” in my new market gaps trading strategy guide which is going to be released ASAP.
Market Close Gap Trade 2 – GBPAUD 05/05/2019
This second gap trade appeared on the same day as the first example and included the same FX currency yet it was an even larger gap in a different direction. GBPAUD gapped up over 100 pips upon the Sunday FX market open and this then produced a gap trade against the current trend. I have marked on the momentum leading up to the gap and it is bullish with new highs made throughout the prior week.
Even though the gap up was against the market trend and I would have been selling against a bullish momentum, I still take these gap trades because over a long period of time they have been found to have a high probability of being filled. This means that once again, if you manage your risk and exposure across multiple “against trend” market gap trades, you can profit from the win rate being above 50%.
You will notice on this market close gap trade that my stop loss is slightly smaller than my profit target which produces a reward:risk ratio of greater than 1:1. This is fine and it is part of my own rules because I believe that you do not need a stop loss larger than 100 pips when trading these styles of market gaps.
Let’s see how this against trend market close gap trade played out.
As you can see in the chart above, the market gap was filled overnight and the profit target was reached before 9am on Monday. The reason why I have shown you this trade as an example is because it involves the same GBP currency pair as the first example but has a gap in a different direction and a completely different outcome to the trade. Again, this goes to show that with these types of “mechanical” and non discretionary trading strategies, the key is to play the odds and profit from the probabilities over a long period of time.
So there we have it, two market close gap trades with two different outcomes. I hope you have learnt a little more about how to set up a simple market gap trade and even try to avoid losing them.
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DISCLAIMER: None of the information posted on this site is to be considered investment/financial advice. Trading is high risk and you should only trade with money you can afford to lose.