Gap Trading The Forex

How To Profit from a Forgotten Trading Strategy that is “RIGHT” 89.1% of the Time

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 Gap Trading The Forex

How To Profit from a Forgotten Trading Strategy that is “RIGHT” 89.1% of the Time

GAP TRADING THE FOREX: HOW TO PROFIT FROM

A FORGOTTEN TRADING STRATEGY THAT IS “RIGHT”
89.1% OF THE TIME
By Jason Fielder

Gap trading has been around for decades in the stocks and futures markets, but it’s
largely ignored by most active traders in the Forex despite its incredibly high accuracy
rate. Before I get into WHY that is, I want to first discuss the concept of “gap trading”.

Here’s how gap trading works: Anytime you see a change in price levels between the
close and open of two consecutive bars on a chart, a “gap” has occurred. Traders use these
gaps to predict short-term movements, and they’ve proven over the years to be highly
accurate indicators in almost every major market.

A Forgotten Art

But if gaps are such an easy (and profitable) way to trade the markets, why have they
been largely ignored among Forex traders? Simple. Without a market close there’s no
opportunity for gaps to occur. In the past, I’ve observed gaps when there was a massive
move in one of the pairs as well as very small, almost random gaps, but unless you’re
staring at a tick chart you probably won’t see them. Plus, these gaps are not tradable
because the gaps are too small and the spreads are too large to make a profit.

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 Gap Trading The Forex

How To Profit from a Forgotten Trading Strategy that is “RIGHT” 89.1% of the Time

No, to trade the gaps effectively you need a close, and as you’re no doubt aware the
Forex almost never closes.

Unlike stock and commodity markets which close at the end of day, the Forex only closes
down Friday night through Sunday night. So while most markets offer gap trading
opportunities at the end of every day, you can really only trade the gaps once a week in
the Forex. That may not sound exciting to you if you’re an active trader, but remember
that when gaps do occur they produce an accuracy of 82.6%.

In other words, they’re well worth the wait.

How To Trade Gaps In the Forex

As I’ve already stated gaps are a change in price levels between the close and open of
two consecutive bars on a chart. (For our purposes, the gaps we are looking for occur
between the closing price on Friday to the opening price on Sunday.)

There are only three things that the price can do from Friday’s close:

n Open above Friday’s close, called “gapping up”

n Open below Friday’s close, called “gapping down”, or...
n Open at the same price as Friday’s close, meaning there is “no gap”

When a gap occurs in the Forex market, it can be a partial gap or a full gap. A partial gap
occurs when the opening price is higher or lower than the previous closing price;

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 Gap Trading The Forex

How To Profit from a Forgotten Trading Strategy that is “RIGHT” 89.1% of the Time

but does not gap beyond the high or the low of the previous bar. Another way of saying it
is that the gap has occurred within the high/low range of the previous bar.

See the examples below for further explanation...

Examples of Partial Gaps

A partial gap up occurs when the opening price is less than the high price of the previous
week. As you can see below, the arrow points to a partial gap up.

EXAMPLE OF A PARTIAL GAP UP

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 Gap Trading The Forex

How To Profit from a Forgotten Trading Strategy that is “RIGHT” 89.1% of the Time

A partial gap down occurs when the opening price is greater than the low price of the
previous week. The example below is a fairly small gap, but a gap none-the-less. The
arrow shows where the partial gap down occurred.

EXAMPLE OF A PARTIAL GAP DOWN

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 Gap Trading The Forex

How To Profit from a Forgotten Trading Strategy that is “RIGHT” 89.1% of the Time

Examples of Full Gaps

A full gap occurs when the opening price opens beyond the previous bars high/low
range. As with partial gaps, a full gap up has an opening price higher than the previous
bar’s high. A full gap down has an opening price lower than the previous bar’s low.

The example, below, is of a fairly large full gap up. As you can see the opening price is
greater than the high price of the previous week. The arrow indicates where the full gap
occurred (although it’s doubtful you would even need an arrow for this illustration).

EXAMPLE OF A FULL GAP UP

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 Gap Trading The Forex

How To Profit from a Forgotten Trading Strategy that is “RIGHT” 89.1% of the Time

The example below of a full gap down occurs when the opening price is less than the low
price of the previous week. The arrow indicates where the full gap down occurred.

Variables in Forex Gap Trading

There are three variables worth noting when trading gaps: full vs. partial gaps,
direction and size.

The research that I have conducted on Forex gaps has shown that there is little to no
difference when trading the partial gap compared to full gaps. To put it another way, full

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 Gap Trading The Forex

How To Profit from a Forgotten Trading Strategy that is “RIGHT” 89.1% of the Time

gaps are no better at predicting movement than a partial gap, which means you can feel
free to trade both.

The other interesting variable that I tested was the direction in which the gaps should be
traded based on whether or not the gap itself was up or down. In other words, do you buy
into the direction of the gap or sell against the direction of the gap?

For example, if the EUR/USD gaps down 20 pips; then do I buy or sell? I have found that
whichever direction the gap occurs, you need to trade in the opposite direction. So...

If the currency pair gaps up: sell short

If the pair gaps down: buy

I realize that this sounds counter-intuitive, but the numbers don’t lie. If you trade
AGAINST the gap, you will be correct 89.1% of the time.

NOTE: The research spoken about, above, was conducted on the four major pairs.
And while I would expect the results to be similar across most other currency pairs, it
is suggested that you do your own research prior to trading in a live account.

The final variable I tested was gap size. As you might imagine, the larger the gaps, the
better they were at predicting the direction of the next move. With that said, if you decide
only to trade gaps that are 50 pips or higher, you will obviously miss out on a lot of
potential winners. Conversely, if you trade every gap that is larger than your spread, you
will have too many bad trades to make this system profitable.

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 Gap Trading The Forex

How To Profit from a Forgotten Trading Strategy that is “RIGHT” 89.1% of the Time

So as with any trading system, the key is to find a “happy medium” that works for you and
your overall trading philosophy.

The way that I trade gaps is simple. Use the four major pairs on the weekly time frame
to trade gaps. Wait until there is a gap of at least 15 pips or more and then buy or sell
depending on the direction of the gap. Then, place a stop loss at 150 pips. Finally, exit the
trade when the pair fills the gap and retraces back to the previous weeks closing price.

NOTE: For more information about my research for this and other trading systems,
see: http://www.ForexImpact.com

Benefits of Gap Trading

There are several nice things about trading gaps in the Forex market. I like the fact that
the market opens on Sunday night at 5:00 pm EST. This gives you a chance to put on a
trade before the work week begins. This trade is also easy to spot and there is nothing
that can be interpreted wrong. There’s either a gap or there isn’t.

When a gap occurs you can place your stop loss and exit; then let the trade run. There is
no reason to watch the market unless you just want to.

ACTION ITEM:
This coming Sunday night at 5:00 pm EST on the open of the Forex market watch for
a gap to trade. If the pair gaps up sell short and if the pair gaps down then buy.

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