One of the most common continuation chart patterns watched for by those that trade forex is the gap. The gap is one of three classic continuation patterns used in technical analysis, and the other two are known as flags and pennants.
As the name implies, continuation chart patterns generally indicate that a major trend will most likely continue in the near future. Gap price movements can be in either direction, and so can have bullish or bearish implications for exchange rates.
About Gaps in General
A gap in technical analysis jargon is defined as a break in continuity between price or exchange rate levels on a chart that occurs when they makes a sharp up or down move with no trading in between.
Gaps can be easily discerned on an exchange rate graph. Where normally you would see a trading bar on a graph, a gap or vacuum is present representing the absence of trading at that exchange rate level.
A down gap occurs on a bar chart when the high of a bar’s trading range is lower than the previous bar’s low. Conversely, an up gap would occur when the low of the bar’s trading range is higher than the previous bar’s high.
When Gaps Occur
Gaps most often come about after a period of no trading, such as immediately after the weekend market closure ends. Nevertheless, they can and often do arise during a fast trading session as exchange rates adjust sharply to assimilate new information.
Gaps are usually caused by events that have a dramatic effect on the market’s asset valuation, such as large order imbalances, fundamental news or economic data releases, central bank intervention or natural disasters.
While gaps may be infrequent in forex trading due to the forex market’s round the clock trading hours and considerable liquidity, gaps often occur after central bank rate statements or when the market re-opens on Sunday afternoon New York time after a significant event occurred over the weekend.
In addition, gaps can occur intra-day during speeches by prominent banking or political figures, or after the release of significant economic data, such as the U.S. Non-farm Payrolls number, especially if the result is considerably different from the market’s consensus.
Types of Gaps
Gaps that might appear on forex charts are typically divided into three main types as follow:
• Breakaway gaps – occur when an exchange rate opens at a higher or lower level, breaking out of the previous period’s trading range.
• Continuation gaps - generally appear in a strong up or downtrend and signal an increase in the intensity of the move.
• Exhaustion gaps - occur at the end of a bull or bear move and signal an end to that particular move. This gap has a tendency to be filled.
Only the breakaway and continuation gaps are considered continuation patterns. Exhaustion gaps often indicate the last move of a trend before the market reverses.
The strategy most often used for gaps in forex trading is taking a position to follow the prevailing trend after a pullback or rally to the gap region occurs. Nevertheless, waiting for a gap to fill could be a futile endeavor in the case of continuation and breakaway gaps.