A gap creates a chasm in a price chart…
It is easily noticed, a quick look at a chart reveal multiple holes…
In the figure you see the gap A and gap B are called down gaps, a down gap happens when the last high is lower than the previous low.
You can see the formed gap C of 19 points…
Like down gaps, up gaps occurs also, they are formed when the last low is higher than the previous high (gap C represents an up hole).
You must know that observing gaps are easy because simply they are very conspicuous…
A gap show that the price jumped, its a change that you should benefit from…
Any recognized price change can be a trading opportunity for you…
If a price chart displays a strong uptrend or downtrend…
You should search signals of any price mutation where holes can be one of the indications of trend changing probability…
Like you see in the image below the formed runway gaps are a signal that the price will continue in the same direction of the major trend line.
If you noticed a sideline trend, as an analyst you are forced to wait until the market movement indicate a rebound to the upside or a downside trend….
Types of gaps
There are many types of gaps, to define a gap type it depends on the market price context, some types you should enter them in your trading strategies, others you must avoid to use them…
Breakaway Gap: it is the hole that occurs at the beginning of an uptrend line, breakaway voids are the most profitable kind of gaps.
[If you find any breakaway gap there is a high probability that the price will change its direction like you see in the image below]
Runaway gap: it is the gap that occurs along with the trend line. It is named also ”measuring gap”, it appears, during strong trend lines with few correction lines.
Exhaustion gaps: they occur at the end of an uptrend line, you must know that experts advise traders to not trade exhaustion voids.
When exhaustion holes occur two things could happen:
- The price can reverse its direction.
- The price can enter into a consolidated state.
These kind of gaps can be utilized to exit a trade not to open a new one…
Many other types of gaps exist, technical analysts summarize them on the following points:
Common gaps: they happen in an illiquid market where the price is in a sideline situation.
Ex-dividend gap: this hole is private to the stock market, it occurs when companies pay dividends and adjust the price of their shares.
Suspension gaps: occurs in future markets.
Opening gaps: it occurs simply, for example, if the open price (of a currency or a share) of today has a different range with the closed price of the previous trading session.
Breakaway and runaway gaps have a significant impact on the price chart…
You must continually be aware of them…
They could reverse the market at any time they occur…
The impact of exhaustion gaps isn’t significant, professional traders do not trade them…
Other gap types are not traded, I just mention them to let you know about them as a technical analysis knowledge…
Gap size impact:
The size of a gap could affect the price movements, the length of a hole haven’t a big impact on price movements, what influence the markets is the volume.
More trading volume is strong, more the gap will have a strong impact on price movements even if the gap length is small.
When a large gap occurs the psychology of traders (Greed and fear) guides them to enter against the last formed trend, this situation is called “Fading the gap”.
Gaps as a support and resistance lines?
Holes could be resistance and support lines, this helps you to define zones where the price can reverse its direction…
Specifically, this could help you to identify swing highs and lows which going to facilitate the exit decision of your open trading positions.
Two situations exist:
If you notice an uptrend with runaway gaps…
Those voids are often support lines…
If the price hits the last support (last gap line)…
Then:
It’s the perfect time to exit the trade and collect your profit from the market.
The other situation:
You apply the same logic for down trends with runaway gaps, resistance lines can help you to here to identify the perfect exiting time.
In Japanese candlestick charts a gap refers to a window…
To form a window the chart must display two candles without an overlap between them, this is called “disjointed candles”.
There are four types of windows:
- Running Windows: is the window that occurs with a large up candle, it is called “running window” because the market run in the same direction of the window.
- Rising window: whatever trend is, an up candle that appear after a gap is called a rising window.
- Falling window: the falling window is simply the reverse of a rising window.
- Closing window: after a window is formed a candle comes to fill the hole this is the closing window.
Notice that: If a window doesn’t fill after three candle construction, there is a huge probability that the price will continue its direction (in the direction of the window).
[This what Japanese analysts say, and it is verified and works fine for me]
Windows as supports and resistance:
Rising windows are support zones and falling windows are resistance zones…
Japanese candlestick analysts say that “corrections stop at a window”
This means that windows are a powerful zones where the price come to the end of its corrections…
If those zones are broken, then the price definitely will change its direction…
After every hole, trader’s psychology influence traders to enter in the opposite direction of the trend.
Here is a the rule:
According to Japanese technical analysts:
In an uptrend market, after three up windows there is a high probability that the market is in an overbought state, the trend often changes its direction.
In a down trend market, after three down windows, you should pay attention to the trend because it may reverse its direction to an uptrend.
PS: you can use the momentum indicator to confirm gaps impact, momentum is able to identify high probability overbought and oversold points, this will enhance your trading results.
Remember that:
A trader is an analyst that identifies the time where the trend will reverse its direction from an upward to a downward trend or from a down trend to an uptrend…
Many traders try to enter a trade when the market is rising (uptrend) or falling (down trend), this isn’t the goal of technical analysis…
The right way is to track the market until you notice any major trend changing probabilities…
Tasuki gaps
There are two types of Tasuki gaps:
- Tasuki upward gap: it is created by a rising window formed with a white candle (up candle) followed by a black candle (provided that the top of these black candle is below the close of the white candle).
- Tasuki downward gap: this kind of Tasuki gap is simply the reverse of the Tasuki upward pattern.
I mention them just to let you know about them…
… If you misunderstand them
So don’t be worried…
They are not important because they occur rarely and they have a low impact on the market price.
It’s not a useful task for a professional trader to identify Tasuki gaps or patterns.
Many other gap patterns occur during trading:
Upgap side by side white lines: many aspects should be verified:
- Uptrend market
- Window occurs with a white candle
- The following candle is white
- Those 2 candles must have the same size and the same open price.
The two white candles give you a signal that the trend will continue its direction, its a bullish continuation signal.
Down gap side by side white lines: these kind of voids occurs rarely, this why you shouldn’t give them much importance during your trading.
The conditions are the same ones for the up gap side by side white linesexcept that you must be in a down trend market.
Despite the fact that these patterns occur with two white candles the down gap side by side white lines gives you a signal that the trend will continue its direction (bearish market).
Two black gaping candles: to form this pattern you need a downside gapfollowed by two black candles.
These patternis a signal that the price will follow the direction of the black candles (bearish market).
Gaping doji: a doji is a candle without a body where the open price equal the close price of the candle, a gap that occurs because of a doji is called a “gaping doji”.
These pattern occur rarely in the market and you mustn’t give it much importance.
Collapsing doji star: these pattern occur rarely it contains two windows with a doji in the middle, the first candle is white, and the candle after the doji candle is a black one.
These patternis a confirmation that the market will reverse to a bearish market.
Abandoned baby top: the pattern is formed if the following condition is verified:
White candle followed by a doji candle which is above the white candle, followed by a black candle below the doji candle.
When I say above or bellow candles, I mean the real body of those candles, the candle’s tails are not considered.
These patternis also rare and occur few times a year.
Abandoned baby bottom: its formed by a black candle followed by a doji below it, followed by a white candle above the doji.
These doji appear rarely for few times per a year.
Why gaps occur?
There are many reasons that cause gaps in a trading chart:
- Economic events: when a significant event occurs like a natural disaster.
- When an essential activity stopped: for example, if Facebook was hacked by hackers and the Facebook’s server get down, multiple gaps will be displayed in Facebook share’s chart.
According to forex-tribe .com in a study between 2000 and 2010, EUR/USD has displayed bullish 74 gaps, 49 of them are filled, it means that 34% of the occuring gaps are significant opportunities to benefit from.
34% of gaps occurring EUR/USD are profitable!
But how about 66% of those holes?
Will those gaps deserve a try to trade them?
The bottom line is how can you know if the gap is profitable or not?
The simple method to make right trading decisions using gaps is to define the major trend line of higher time frames.
If you trade using the 4H time frame and a runaway up gap occur…
Just open the daily time frame and define the major trend line you have…
Two situations you will confront:
- The major trend line of the daily time frame is up
- The major trend line of the daily time frame is down
In the first situation the gap is credible, you can then enter in the direction of the gap…
In the other situation where the major trend line is down, don’t take any decision, you can’t predict the future price in this case…
For other gap types (breakaway and exhaustion gaps) you have to enter against the 4H major trend and in the direction of the daily time frame.
How to use momentum and gaps to trade?
Now:
I think you are able to identify gaps…
But this is not enough…
You need to use multiple indicators to confirm the gap impact…
If you make a trading decision just according to the occurrence of the gaps then you will make wrong trading decisions
Gaps aren’t enough…. You need confirmation!
The momentum indicator is a simple indicator that determines overbought and oversold points…
For example:
If you notice a runaway gap in an uptrend and the momentum indicator display an overbought point…
Then you must use this point as a resistance because the price will reverse its direction to a down trend…
Placing a sell stop in these resistance line can be a profitable trading position…
The same logic is applied for a runaway gap in a down trend situation.
Another case to take into consideration that:
If you observed a breakaway with an oversold point, then you should buy these share/currency.
How to use volume and gaps to trade?
Volume is an indicator that calculates the number of tradable currencies (for forex market) or shares (for the stock market) in a particular period of time.
As the momentum indicator the role of the volume indicator is to help you to expect trend changes…
If you trade in an uptrend market…
And you see that the volume has a down trend..
Then there is a high probability that the price will change its direction to a down trend…
[You apply the same instructions if you trade in a down trend market]
You need to confirm gaps using volume and momentum indicators…
Just to make sure of the gap impact…
This will enhance your chances to gain more trades!
You have probably been wondering why I put in the decision field “No decision” for the runaway gap pattern…
Like I mentioned previously above, trading is:
The art of expecting the time where the trend will reverse its direction for a long time…
Not trading just temporary throwbacks…
For exhaustion gaps you shouldn’t trade them because they do not affect the price movements…
Otherwise, breakaway gaps are the most profitable gaps that you should integrate with volume and momentum indicators to confirm the gaps impact.
Conclusion
As you see in this article I mention how it is profitable to trade gaps…
To be honest, they don’t occur a lot in the market…
But when they occur, you must trade them in order to limit risk of losing trades…
And enhance your profit
Now:
Tell me…
Do you use the gaps to trade?
If you have any question or you need any clarification, leave a comment below.
Article source: http://investoune.com/the-ultimate-g...de-using-gaps/