What is a Forex gap and its positive and negative aspects?
The currency exchange doesn't operate continuously; its activity is suspended on weekends and holidays. However, exchange rates still fluctuate, resulting in a phenomenon known as a Forex gap.
A Forex gap is a break in currency quotes, in which the previous time frame closes at one price, and the next opens at a completely different value.
Is the occurrence of a price gap easily identified by looking at a currency chart? Upon closer inspection, it's immediately clear that the new candle opened at a price different from the previous one.
Typically, this phenomenon occurs during breaks in the operation of the currency market, but sometimes it can also occur in the middle of a Forex trading session .
The reason for this phenomenon is strong news that causes strong volatility and rapid trend movement in the market.
Such news often appears on weekends when the stock exchange is closed, so Monday is the record-holder for the number of gaps.
How to identify a Forex gap on a currency pair chart
To see a gap that has occurred in the Forex market, simply switch the chart view in the trader's trading terminal to Japanese candlesticks or bars. Then scroll through the currency pair's history.
Gaps can be caused by events that occurred over the weekend or a significant and sharp trend movement. For example, a natural disaster in the country where the currency is traded, such as a flood in Australia, will inevitably cause price gaps on the charts of all currency pairs that include the Australian dollar.
A gap can move in two directions depending on the event and whether the currency (base or quote) is our currency. It's easiest to understand the nature of this phenomenon with specific examples.
Let's take the previously mentioned Australian dollar as our currency; the factor influencing its exchange rate is the same flood that occurred over the weekend. First, we determine the direction of the impact; in our case, it's definitely negative, meaning the Australian dollar will decline.
At the same time, pairs where this currency is the base currency (AUDCAD, AUDJPY, AUDUSD, etc.) will experience a downward gap. As for the EURAUD and GBPAUD instruments, the opening price of the new session will most likely be higher than the closing price on Friday, and an upward trend will form due to the decline in the Australian dollar exchange rate.
Pros and cons of gap trading in Forex
The main drawback of this phenomenon is that stop orders are triggered at the first available price, which is often less favorable than the stop loss set by the trader.
As a result, the planned loss increases several times, and sometimes a Forex gap can lead to a complete loss of the deposit.
At the same time, there are numerous Forex strategies based on price gaps. You can find an example of one in the article " Gap Strategy in the Forex Market ." Unfortunately, most of these trading options are of questionable effectiveness, as the trend after a price gap doesn't always follow a consistent pattern.
To protect yourself from unpleasant surprises, before placing orders, first analyze the historical trend movement before the price gap occurred.
