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Why do Gaps Occur in The Forex Market?
Written by: PaxForex analytics dept - Tuesday, 26 December 2017 0 comments
A common misconception among forex traders is that the market is closed over the weekend. In fact, the forex market never closes, not even on weekends or holidays. When retail trading closes for the weekend, your broker simply denies you the ability to trade. Gaps mainly occur when the particular instrument and/or market, in general, makes an announcement that is unexpected, or a related event somewhere in the world takes place. In fact, gaps can follow any sudden change in investors’ perceptions about a stock, fund, future or currency.
A “gap” in the market is the price movement of an asset, including a currency, stock, commodity, etc., during a period when no trading has occurred. Most commonly, gaps in the market are seen in the difference in price of the asset between its closing price at the end of one trading period and its opening price in the next trading period, such as overnight or over the weekend. However, gaps can also occur over shorter time frames, which is what some day traders use to make trades.
Gapping in the market occurs due to various factors, including the regular buy and sell pressures, political and economic events, economic or policy announcement by a country, market sentiment, acts of terrorism, natural disasters, or for that matter any news event that is of
high impact for a nation. In short, gaps are most often created by fundamental changes, making it all the more important for traders to remain updated with the economic calendar, as well as other geopolitical events.
In the forex market, it is not uncommon for a report to generate so much buzz that it widens the bid and ask spread to a point where a significant gap can be seen. Gaps can be either a down gap or an up gap. The former occurs when the opening price is lower than the closing price, while the latter occurs when the opening price is higher than the closing price of the previous trading session. While this is broadly how gaps occur, gaps are classified into four types: Break Away Gap, Exhaustion Gap, Continuation Gap and Common Gaps.
Gap trading is tricky, but if you know which gaps are tradable and which are not, it should be a lot easier. Try to spot different gaps on your platform and observe how the price behaves after the formation of a gap. Those who study the underlying factors behind a gap and correctly identify its type can often trade with a high probability of success. However, there is always a risk that a trade can go bad. Gaps are risky (due to low liquidity and volatility), but if properly traded, they offer opportunities for quick profits.