Forex Gap Trading Plan – Part 2

Tim Black hosts the live trading room for the Asia trading session. His background is in computers and technology. He is addicted to technology, charts and technical analysis and enjoys teaching and sharing his viewpoints in these areas.

In Part 1 of this series, we discussed what the gaps are, how and why they form, and what you need to take advantage of them. In Part 2 we will discuss how you, the trader, can determine where the gap is and whether a trade is possible.

EURUSD Gap May 9, 2010

How do I find a gap?

In short, you find a gap by looking at Friday’s market close on a given currency pair and comparing it to the Sunday open on the same pair.  It’s actually slightly more complex than that because not all brokers close Friday and open Sunday at the same times.  The way I do this is, I look at the close of both the 4 pm and 5 pm (all times in this series are in US Eastern Time) Friday candle (my broker Oanda shows market movement right up until 5pm on Friday.) I then compare that to the market movement on Sunday and I use the number that is closer to the gap up/down.  In other words, if Friday’s 4 pm close was, say, 1.0000 and 5 pm close was 1.0010 and Sunday’s gap was up, I would consider the gap closed at the 5 pm number (the closest price.)  I recommend that you open a demo account at Oanda so you can see all the weekend price movements (Oanda’s demo account is free and never expires.)

Next, I look at the market movement around 4 pm on Sunday for a significant difference in price from Friday’s close(s.)  If there has been significant movement, I determine if it will make a good trade.

How do I determine if the gap is trade-able?

As we all know, the spreads (the difference between the bid and ask; in other words, the cost of the trade) are ATROCIOUS on Sunday afternoon.  The majors can have as much as a 10 to 20 pip spread.  Some of the more exotic pairs’ spreads can be as much as 50 or 100 pips!  I don’t like this, but I’ve decided that if there is profit in the trade, then it’s still worthwhile to take it.

Here is how I determine whether I will trade a given gap: the first target when the price action turns to fill the gap is 1/2 of the gap fill.  Just to be clear, taking a gap up for example, I take the current market price, subtract the closest Friday close price (4 pm or 5 pm) and divide by 2. This will give me 1/2 the pips for the gap fill.  If this number is more than twice the spread, I will consider this a trade-able gap.

In Part 3 of this series, we will discuss my rules and suggestions for entering the gap trade.

May the pips be with you!
Tim Black
Secret Asian Man 😉

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