Gap trading I’m often asked about gap trading after I post up a gap trade setup. Usually the question is, “ what is my strategy in trading gaps?”, or “What is gap trading?”
Back in June 28-30 this gap happened in spot gold. ( the pink circle) it’s a good example of gap trading from real charts not text book examples.
Well first of all, not all gaps are created equally.
On days where the market, or certain currency pairs gap in price right from the open, gapping with a larger gap from the previous Friday closing price, those are my targeted trading opportunities and here is why!
Any gap which is larger then 30-40 pips or even bigger are good opportunities. The 30-40 is a minimum range in gap totally depending on the pairs daily true range.
Example with the USDJPY pair. The daily range is a smaller range so a gap of 30-40 pips is a good opportunity. I’ve seen gaps of 100 and more in this pair. So weather it gaps up or down we are interested in taking the other side of the gap. Mostly a gap is created by imbalances in the market and one of my rules of trading states...
“nothing moves in a straight line for a long!”
Imbalances correct themselves, overly excited traders pushing price in a straight line and at some point they also take profits. Thus price pulls back ending a straight line move or in case of a gap the imbalances seek to correct just because of the imbalance at the open.
Going into this weeks open I will be actively looking for gaps in currency pairs with tighter broker spreads. Because some pairs will open the week with 10-20 pips or more in broker spreads, those pairs are right off my list of pairs to watch for gaps. Unless these pairs ( larger broker spreads ) gap by 100 pips or more, I don’t bother with them. I don’t even look at them unless same underlying pair in a smaller spreads pair gaps are over sized.
Example: if the USDJPY ( a pair who usually has a tighter broker spread even in low liquidity ) gap is let’s say 50-70 or on the larger side of things, we could expect that the EURJPY or the GBPJPY gaps will also be larger even in those pairs even with broker spreads being larger on average to start with.
So the trade strategy is simple. Using the 15 minute chart I allow the first candle to form. With a larger gap we then enter the trade slightly to the gaps direction after the closing price of that first 15 M candle then the first candles closing price. Example of this would be; if the pair gaps higher and the 15M candle closed at 109.00 then we’d set a sell order at 109.05 or 109.10, because both entries are at higher prices then the 15 M candle close. We at the same time set a tighter stop setting because gaps can get larger before returning to closing the gap. Usually we set the stop above the first 15M candle. But there is a second strategy of playing a gap trade. One could enter the trade just like my example above but also setting more orders in the direction of the gap just in case of an even larger gap move after the opening gap.
After the orders are filled we wait for the closing move. Mind you, these weekly opening gaps are also in the lowest liquidity part of a new trading day, so gaps usually will close heading into the Asian market days open.
We get out of the trade in my standard way. By taking some off as soon as the trade moves in a positive way equal to my stop setting. At the very point we take some profits off we also move stops to break even ( BE ) and allow the trade to hit targets because we have a free ride trade or risk free trade. Once we get to this point of a free ride trade, I always allow the market to take me out at either my targeted profit zone or at BE. No more management or time must be devoted to this trade. Besides the outcome is either profits or no negative effect to my trading account. So my time is better used in finding the next opportunities.
That’s it! That’s gap trading how I do it.
It a higher percentage trade because to a higher degree these gaps close before moving again in their longer term trends.
Side note: should a gap happen counter longer term trend then your profit targets could well be beyond the close of the gap. This would allow for your trade to move with the trend for a longer term or bigger profits. These kind of gaps are my favorite kinds to take. Because the gap in price gives a great price because the gap is counter trend but the trades outcome can be larger by added to the original trade. Because the start of the position is risk free or has booked small profits. So adding orders on doesn’t have to increase risk to the trade. I’d have to do another post on adding to positions once you’ve started a trade in the longer term trends directional move.
Until next time! All the best in your trading.
