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Using Chart Gaps to Build an Effective Trading Bias

Using Chart Gaps to Build an Effective Trading Bias

Tyler Yell, CMT, Currency Strategist

Talking Points:

-The Psychology of Gaps

-When the Gap Doesn’t Fill

-Using the Gap for Future Reference

"There are no facts - only interpretation" Nietzsche

In the Forex market, gaps are rare. A gap shows on a chart when an open prints below the prior close. This often happens to a major shift in the market’s understanding of value from the close of the prior session to the start of the current session.

The Psychology of Gaps

Using Chart Gaps to Build an Effective Trading Bias

Presented by FXCM’s Marketscope Charts

Technicians have loved gaps dating back to candlesticks of the Japanese Grain markets where they were called market windows. A gap or window can give you insight into a strong shift of market understanding and you can look to that gap area to see how the market reacts around that level to see if the sentiment holds. Because of the rarity of gaps in the FX market, their occurrence demands attention because like Opening Ranges, they can provide a bias for you to base future trades against.

When the Gap Doesn’t Fill

Using Chart Gaps to Build an Effective Trading Bias

A gap that doesn’t fill is known as a runaway or continuation gap. This is an exciting gap and can be seen in the earlier to middle parts of a trend suggesting a trend still has further room to run. If the gap immediately fills and the trend reverses, the gap is known as an exhaustion gap and can also be used to set stops against and build your bias. Either way, as they say in London, you should always mind the gap.

Using the Gap for Future Reference

Using Chart Gaps to Build an Effective Trading Bias

Presented by FXCM’s Marketscope Charts

A gap that develops near a common target and pushes price past that target can be a significant sign that strength is set to continue. This recently developed on EURUSD near the 100% Fibonacci extension from the May 8th top to the correction that ensued during the month of June. The 100% Extension was set around 1.3250 as shown above. When a weekend gap caused price to trade through that level and not attempt to fill, that pushed the bias to the next Fibonacci Extension level of 161.8% at 1.2905 that is near where we’re trading on this week’s open.

Closing Thoughts

A good gap is a terrible thing to waste. As traders looking for information to build a bias around, gaps provide a strong shift of sentiment that you can use. A gap communicates to you that whatever price was be bid to enter a trade is no longer valid based on the new information and if this “new” information is just the start, then the trend can and likely does continue.

Lastly, gaps cannot be anticipated reliably because news is never completely known or to what point it is priced in. Therefore, as traders, we need to keep it simple and react with stringent money management so we can be in these strong trends where gaps develop in favor of the trend and can ideally carry us to our next target.

Happy Trading!

---Written by Tyler Yell, Trading Instructor

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.