As you would expect from a financial market that sees an estimated $5.3 trillion during each 24-hour period, the foreign exchange offers various opportunities for investors to profit on a daily basis.
Take the phenomenon of the so-called “forex gap”, for example, which typically occurs during sharp breaks in price with little or no trading in between. These gaps may emerge during the weekend closure of the forex market or in the moments following a major news announcement, while they offer limited windows of opportunity for traders across the globe.
In this post, we’ll explore the concept of forex gaps more closely while asking how you can profit as an investor.
The term forex is short for foreign exchange. It is the international currency market where traders buy and sell dollars, pounds, euros, yen, yuan, etc.
Why are Gaps Important and How do they Work?
The importance of gaps should not be underestimated, despite their relatively understated nature.
In simple terms, gaps are important as they offer a unique insight into market sentiment. So, when a market gaps up, this means that there were no traders willing to buy at the levels set before the break.
There reverse is true when a market gaps down, which hints at far greater demand and a potential upward trend within the space.
The primary concept behind this type of trading is the idea that “price will always try to fill the gap”, on the presumption that because there’s no support or resistance within the gap, an asset’s price has the freedom to shift inside the available space.
This can often result in corrective price action, as price reverse and fill the gap almost immediately after it occurs.
In the forex market, gaps then to be focused around news and developments that occur when trading avenues are closed (typically during the weekend). The opportunity to profit comes from the fact that the forex market is only closed to retail traders during this time, however, clearing the way for banks and hedge funds to manipulate and exploit said gaps.
How do you Capitalise on a Forex Gap?
While gaps are generally defined as being the empty space between two consecutive candles, this understanding often varies in the forex market.
This is because forex gaps are often characterised by the empty space between the opening price on Monday and the closing one from the previous Friday, and it’s important to recognise this when looking to exploit such spaces.
Beyond this, you’ll also need to select a currency pair that boasts a higher level of volatility. This creates more opportunity for price movement within a relatively short period of time, with the GBP/JPY pairing offering a relevant case in point.
Other pairings include those that regularly form large weekend gaps, namely EUR/GBP, GBP/CAD and even GBP/USD in some instances.
Similarly, you’ll also need to leverage the tools on trading platforms to identify viable gaps in the forex market. Typically, these gaps should be at least five-times the average spread for the pair, as anything less may be considered as irrelevant and unlikely to deliver a profit.
When it comes to closing your gap trades, you’ll need to ensure that this is done five minutes before the market closes on Saturday. This will safeguard your investment, while minimising the risk of lost profit in the near-term.