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Whenever the Forex market opens with a large gap I get a barrage of emails about gap trading in Forex. The conventional wisdom in Forex is that gap trading is highly profitable and easy. In this post I take a look at just how reliable and easy gap trading is. Gaps are empty spaces between the close of one candle and the open of the next. In Forex gaps are not very common and they usually only occur at market open on Sundays. Stock and commodity traders have been exploiting gaps for decades.
Since the stock market closes each day gaps are much more common. The concept behind gap trading is that price will always try to fill the gap. This may sound illogical but there are some logical reasons for price to fill gaps in the stock market.
Generally when price gaps there is no support and resistance in the gap area. This means that price has free room to move inside the gap. Over the past few years people have started trading Sunday evening gaps in Forex. The concept is the same, gap traders think that price will always fill a gap. Every Sunday gap seen this year has been filled but one trade moved pips on the opposite direction before the gap was filled two weeks later.
Another gap was filled within two days but the price move 87 pips on the opposite direction before returning to fill the gap. I have compiled statistics in order to analyse the profitability of gap trading. To compile these statistics I needed a basic gap trading system. For the purpouses of this analysis I decided to use a very basic system.
Provided the gap is 20 pips or wider trades are entered as soon as the market opens on Sunday. As soon as target or stop is hit. Since the Forex market has no central exchange there is no official open or close time in Forex.
This means that gaps may appear different dependant on your broker. This could lead to different results than the ones below. Five out of the nine trade were losses. This is attributed to the win loss ration of 2: These stats show how unreliable gap trading can be.
This year we have had nine gaps, eight of those gaps have been filled and one remains unfilled. The table below shows you the floating pip loss you would have needed to endure for each gap to close. Three of these nine trades required a floating loss of more than pips before the gap was filled.
It is illogical to leave a trade open for pips in the hope of making 43 pips when the gap is filled. One of the trades had a pips floating loss and the one that is currently has had pips. So even though most gaps are filled some require you to suffer large floating losses before being filled. However, I have only tested one pair with four months worth of data. To be definitive I would need to test at least five pairs with one year of data. I might do this in future but at the moment it is more important to address the flawed wisdom in the Forex community.
If I see a good trade I wont let an unfilled gap keep me out of the market. The statistics make it clear that gaps are not always filled quickly, so they should not impact my trading decisions. I think the prevailing wisdom about gap trading in Forex is wrong. While it might be possible to make some profit trading gaps it is not as easy as people suggest.
So next time somebody tells you that the price has gapped so you should trade the fill, tell them that gap trading is a roll of the dice. Click here to cancel reply.
Email will not be published required. I trade gaps every Sunday that the market offers a viable one to enter. I rarely enter at the open but wait to see if gap is going to widen as many did this past Sunday. Because of the election volatility I exited most of my gap trades well before they closed. I never said definitively that gap trading is not profitable. With different strategies gap trading can be profitable. My guess is that non of the EUR denominated pairs are.
If you are going to do gap trading then I would recommend reading lots of news on the weekend. With everything going on in Greece my guess is that a lot of the gaps for the EUR have not closed as well as they usually do. I have read the theory, your work on the facts is extremely interesting, a most interesting analysis. Yeh, there has been a few recently. I think I might take a look at a few more pairs and expand on this post.
Hey DolphinTrader, glad your enjoyed the post. I am guessing this answers your question from yesterday? I have a question that relates to trading gaps in a slightly different way: This is a very good question but I am afraid I cannot answer it now. Hi Nick, Worthy clarification and a good question by Rjohnston4x. Perhaps it is but you would need to exit early a lot of the time. Hey Nick, Thanks another great post explaining Gap trading, not somthing I have looked at and probably will not bother looking at.
My last question was not articulate. All I wanted to know is: Thank you Nick for this insightful article.
I was intrigued, somewhat, with the idea of weekend gap trading. I now believe it is just too risky, for me anyway. What Is Gap Trading? So even though gaps are almost always filled trading gaps in not always viable. A Closer Look at Gap Trading I have compiled statistics in order to analyse the profitability of gap trading. The System To compile these statistics I needed a basic gap trading system.
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