At the opening of trading sessions on Monday we often see that quotations of currency pairs leap from one side to another, immediately forming rather serious gaps in comparison to values of Friday closing. Such leaps at stock exchanges are called GAPs. A GAP literally means a “leap”. Experts of Forex market told us why such occurences happen and whether one can make money from this.
A good GAP is a leap by tens of points
According to specialist of YA-HI.com company, GAPs almost always arise at the opening of weekly trading session. Although, they are not always seen with the naked eye, for leaps may sometimes amount to 1-2 points. Such gaps are not worth attention. But when this refers to a 30-40-point or even bigger leap, you can be sure that there is a real chance to get income.
It is well known that serious GAPs arise rather often. However, if we look at any currency chart, we will not find a single gap that remained unclosed. According to experts, this is the main proof that GAPs can be made money from. Any gap will always strive to closure, even if movement in the direction needed contradicts the current state of trade. The question is only when the GAP will “close” – during the next 15 minutes, or in several weeks. What is more, financial instruments sometimes keep actively moving towards the GAP, thus considerably enlarging it. In such a case if at the opening of a trading session a trader sets an order for covering a GAP with considerable capital, he/she risks to meet insufficient margin level. Then stop out will come earlier than currency pair or other instrument reaches the expected value.
Therefore, before creating one’s own strategy of working with GAPs, it is necessary to understand why they arise. There exist several market reasons of GAP formation. First of all, during weekends, when markets do not work, some important macroeconomic information comes out, and it may change traders’ spirits. Then participants of trading sessions massively open or close orders the first second the trading session opens. As a result, supply-and-demand situation changes, and quotations make a leap.
Besides, GAPs often arise due to purely technical reason. For example, when an instrument reaches the level of support or resistance, where a great number of stop orders, delayed orders, etc. is accumulated.
Watching the market shows that every currency pair on average has one good GAP per month. As far as any broker has tens of highly liquid trading instruments, it is worth following every opening of a trading session on Monday in expectation of a GAP. However, we should warn you that some brokers experience so-called pseudoGAPs, which have nothing to do with market gaps and cannot be used for composing a trading strategy. For example, if a company closes trading one or two hours before the world market does. Or when a broker open trade on Monday an hour or two later than everyone else. This time is enough for any financial instrument to make a certain way. The chart will then show a GAP, although in fact there could be no considerable leap.
So, before starting to make money from GAPs, make sure that your broker opens and closes trade together with the whole world market.
What is the Likelihood of Getting Income from GAPs?
Hereinabove we have tried to explain why GAPs arise. Now we will tell a few words about why they strive to closing. The point is that when market opens considerably higher or lower than Friday closing, numerous delayed orders, which were set at the moment of overbought or oversold market, can work out. If this happens, GAP will most likely be covered in the nearest hours or even minutes. Traders find this most the successful time for earning at Forex, when risks that situation will progress by the unpredicted scenario are very low.
Although, GAP may gail to the reach level of accumulating delayed orders. In such a case its closing should also be expected, but it will most likely happen much later. Let us admit that many traders have not only known about benefits from trading on GAPs for a long time, but they are also trying not to loose a chance to make money from gaps. Therefore, before closing trade on Friday they set delayed orders directed to the center in both sides. If there is enough of such orders, this heats up the situation and makes financial instruments move like market participants expect.
At the same time, one should remember that not all GAPs close during a relatively short period. The cases are known when this has been waited for weeks, or even months. In which case quotations moved far from Friday levels, thus bringing considerable losses to traders. And covering could only happen when an instrument had a short-term reversal. Such situations are rather dangerous for traders. Therefore, it is necessary to learn to correctly define correlation of risk and expected profit, as well as reduce losses by setting stop losses.
Eventually, if you believe that GAPs always close (and this is proved by trading history of any currency pair), you do not necessary need to risk your capital. If an instrument continues moving actively, thus enlarging a gap, it is better to set some losses and then set a delayed order in the needed direction; the order can be moved closer to current quotations as they distance from the level of closing a trading session on Friday.
Analysts of YA-HI.com company claim that the likelihood of closing a GAP for GBP/USD, EUR/JPY, GBP/JPY, and other major currency pairs amounts to about 70%. Most interesting point is the fact that most highly liquid pair EUR/USD quickly covers a gap only in two thirds of cases. However, this also is a good result, for most unpleasant surprises can be expected from exotic pairs; therefore, they are not worth experimenting with. If a gap amounts to less than 10-15 points, trade on it is considered risky. What is more, if during the nearest thirty minutes after opening of a trading session on Monday quotations keep moving in the direction of a GAP, then likelihood of its closing in the nearest future considerably decreases. Therefore, experts advise either to use delayed orders or enter the market not earlier than the first thirty-minute candlestick is over.
Very often a gap is covered with a “reserve”, when quotations move further than the level of Friday closing. However, in order to increase one’s chances of getting a profit quickly, experts advise setting take-profit slightly higher than a Friday level. By the way, if such stop order works out, but а GAP remains unclosed, you can enter the position again, when the instrument reaches the level of weekly opening again. Although, this will be a more risky transaction.
While trying to make money from GAPs, do not forget about stop losses. Experts believe that the most optimal level for setting a stop loss is half as much as the profit expected from a take-profit. For example, if the profit is supposed to amount to 40 points, then probable losses should be limited to 60 points. Statistics shows that in 70% of cases you should make money quickly; therefore, you can get income in a long-term perspective by constantly trading on GAPs:
70(%) х 40 = 280 (profit);
30(%) х 60 = 180 (loss).
As far as we can see, correlation of profit and loss at such limitations amounts to 280 : 180 = 1.556. Reduction of stop loss in relation to take-profit will lead to rising a number of case when a profit is set. If a stop loss is increased, the number of cases when such orders work out will most likely remain the same. But losses will increase rapidly.
