Good day to all.
Welcome to another koala forex education series. Learning forex made easy!
Today let us discuss about forex gaps.
What is a forex gap?A forex gap most commonly refers to a difference of the price of a currency pair on the start of the new trading week compared to price at the previous week’s closing.
For example,
Friday close: EUR/USD 1.3600.
Monday open: EUR/USD 1.3700.
There you go, a gap of 100pips!
As i mentioned earlier, a forex gap most commonly refers to a weekend gap.
However there are other instances although less common where forex gaps happen too.
For example during an adverse development of a financial / economic issue. These gaps are usually smaller in sizes.
Therefore forex gaps can possibly happen at anytime of the day as long as there is a disconnect of the price of the currency pair.
Why do forex gaps happen?In the strictest sense, these gaps are not gaps per se. We know that forex is all about the different participants of the market’s expectation of exchange of one currency for another. ( Read the “Learn Forex The Right Way Series. What is forex? ” article for more information on what forex actually is. ) “Gaps” are simply a change of expectation beyond a single pip. In your charts, it shows up as a “disconnected” progression of candles.
Therefore in the context of adverse developments, an event may have so much impact that investors “suddenly” have a much different expectation of exchange, resulting in a “jump” of bid/ask rates.
In the context of weekend gaps with the different participants in mind, while most of our retail brokers are closed for the weekend, the reality is that the world still revolves and financial / economic events still take place or develop.
For example, a Group of 7 financial meeting to discuss the current state of financial issues ( which is probably rather consequential ) may take place on a Saturday. Any unexpected result of this meeting may cause expectations to change. In reality, the currency pairs have moved during the weekend but your retail broker which is closed for the weekend will not update it’s chart. When trading start on Monday, your retail broker updates it’s chart, gets the latest market prices and voila a forex gap is seen!
How can we handle forex gaps?In my opinion, the honest truth is no one can predict with 100% accuracy what happens next in forex. There is no crystal ball. The best we can do is to mitigate the risk of forex gaps.
Forex gaps can result in margin calls, especially if one is over sized on one’s position. Therefore you should always practice proper money management at all times. I had three margin calls before and one of which resulted from a gap. The gap was so big that it wiped my entire account and went into negative. ( There was no way for the broker to close my positions over the weekend )
If you are a short term trader ( days at most ) consider carefully before leaving trades over the weekend. Definitely keep a lookout for economic events scheduled for the weekend. Make sure you practice proper money management. Many investors take profits on Fridays. This is not without a valid reason. They probably do not want to face the risk of holding the positions over the weekend. Personally i wouldn’t want to as well
If you are a long term trader and is trading the right way, you probably have planned your trades well and have wide enough stop loss allowance to sustain most but the worst of gaps. Practice proper money management and this may save you from catastrophic events
A last note before i end this article. You may have heard people speculating on whether will the forex gap close.
When a forex gap closes, it simply means that the price goes back to the level it was before the gap. One possible reason for a closure will be that the gap may have happened because of a knee jerk reaction to an event. Once the commotion surrounding the event disappears, the market may realize that ” Hey, that event wasn’t so great after all ” and normal economic forces take over and bring the price to where it was before the event. Do note however that there is no 100% rule that forex gaps will close. I will like to remind you again that nothing in forex is 100% confirmed.
I hope this article shed some light on forex gaps.
