Money is always changing hands in the flexible Forex Market. In fact, so much money changes hands in the market that the liquidity available in FX makes this one of the more flexible markets around. However, when a news shock hits the market and a gap appears on the price chart that can be used by you to time entries going forward.
What Happens When You See A Gap On The Chart?
A gap is often caused by a news shock that changes what was previously priced into the market.
An example can be a Central Banker discusses new plans for the Currency that hadn't been revealed before or a surprise reference rate cut. Whatever the reason, a gap is caused because whoever is in favor of the gap refuses to sell at a prior price that the market was accepting and thus no prices are printed at certain levels.
Therefore, the next price that is accepted by whoever was in the news' favor will be the next price to print thereby creating a gap on the chart.
How To Mind & Trade The Gap?
Now that you know why a gap is created on the chart, a news shock, it's now time to address how you can trade a gap or manage a current Forex trade when you see a gap. If a gap happens in favor of those who are buying, also known as being long, then you can treat that gap in one of two ways. First, you can treat that news gap as a form of support, or a price floor, and look to enter into a buy trade if the price action favors a buying trade by seeing a lack of conviction or follow through near the gap which would likely result in another push higher.
Second, if you look to hold longer-term or swing trades, you can put your protective stop below the gap. Because the gap was caused by a fundamental change in the understanding, it stands to reason that if there is no opposing or equivalent shock that the gap may stand as a focal point on the chart moving forward.
Therefore, you can use that information as a way to time
In the summer of 2013, there was a lot of discussion about who would most likely take over as Chairperson for the Federal Reserve. This person would have a very difficult task ahead of them as they would be in chart of making sure the Quantitative Easing programs put in place by Ben Bernanke from 2008-2013 would be carried on appropriately and also carefully unwound. In August, word started going around that Larry Summers was a frontrunner for the position and due to his track record, he was seen as someone who would be a bit more dollar positive than the other candidates which gave the dollar a good amount of buyers after a top in July.
On a weekend in September, a new rumor spread about Larry Summers. That rumor was that he was withdrawing his name from contention which left the then runner-up, Janet Yellen, as the clear candidate most would count on to take the position (which she did). Janet Yellen was seen as someone who would keep policies in place that were much more US Dollar negative and when she was standing alone as the front runner, the markets opened on Sunday night with a decent gap on all currencies against the US Dollar.
One crucial gap was on the NZDUSD (New Zealand Dollar vs. US Dollar). Since the market opened on the 15th of September, the gap area (around 0.8150-0.8170) has been tested multiple times but we've yet to see a follow through of any test of that level because whenever price trades near that level we quickly see a retracement to the upside.
Gaps are a great way to see a fundamental shift in the price action. This type of jolt can be a great sign for you to identify where a stop can be placed or where you can enter a trade. Keep an eye out for gaps in the future as there can lay a good deal of opportunity when one develops.