Step-by-Step Guide to Forex Gap Trading Strategy

 

Step-by-Step Guide to Forex Gap Trading Strategy

Forex gap trading is a strategy that takes advantage of price gaps that occur when the market opens after a weekend or significant news event. These gaps can create trading opportunities as prices often attempt to "fill" the gap. Below is a step-by-step guide to executing this strategy effectively.

Step 1: Understand What a Gap Is

A gap occurs when the opening price of a currency pair is significantly different from the previous closing price, creating a space or "gap" on the price chart. Gaps typically happen due to:

• Weekend market closures
• Economic news releases
• Major geopolitical events

There are different types of gaps:

1. Common Gap – Random, often insignificant, and usually filled quickly.
2. Breakaway Gap – Signals a new trend and may not be filled.
3. Runaway Gap – Happens in strong trends and is rarely filled.
4. Exhaustion Gap – Appears at the end of a trend and is usually filled.

Step 2: Identify a Gap on the Chart

• Look for a noticeable price gap when the market reopens (Sunday evening for forex).
• Check if the gap is at least 20-50 pips in size (small gaps might not be tradable).
• Compare the opening price of the current candle with the closing price of the previous one.

Step 3: Determine If the Gap Is Tradable

Not all gaps are worth trading. Follow these rules:
✅ Trade only common or exhaustion gaps, as they tend to get filled.
❌ Avoid runaway or breakaway gaps, as they indicate strong momentum.
✅ Check that the gap isn’t caused by major news, which can lead to unpredictable price movement.

Step 4: Wait for Confirmation

Before entering a trade, confirm that the price is attempting to close the gap:

• Use candlestick patterns (e.g., reversal candles like doji or engulfing patterns).
• Check support and resistance levels to see if price respects them.
• Observe if the market is showing lower highs/lower lows (for sell trades) or higher highs/higher lows (for buy trades).

Step 5: Enter a Trade

For a Gap Up (Price Opens Higher Than Previous Close)

Setup:

• If the price starts dropping after a gap-up, enter a sell (short) trade.
• Target the previous close (gap fill level).
• Stop loss above recent highs or a technical resistance level.

For a Gap Down (Price Opens Lower Than Previous Close)

Setup:

• If the price starts rising after a gap-down, enter a buy (long) trade.
• Target the previous close (gap fill level).
• Stop loss below recent lows or a support level.

Step 6: Set Your Stop-Loss and Take-Profit

• Stop-Loss: Place it above/below the nearest swing high or low.
• Take-Profit: Target the previous close (gap fill level).

Risk-Reward Ratio: Aim for at least 1:2 risk-reward to make the trade worthwhile.

Step 7: Monitor the Trade & Exit Accordingly

• If price struggles to fill the gap, consider closing the trade early.
• If price reverses aggressively against your trade, cut losses to protect your capital.
• If price reaches the previous close (gap filled), exit the trade for profit.

Bonus Tips for Successful Gap Trading

✔ Trade with the trend – Gaps in the direction of the overall trend are stronger.
✔ Avoid trading against strong news events – High-impact news can make gaps unpredictable.
✔ Use multiple confirmations – Combine technical indicators like RSI, moving averages, or Bollinger Bands.
✔ Backtest your strategy – Review historical data to see how well gaps fill in different currency pairs.

Conclusion

Gap trading can be highly profitable when done correctly. The key is to identify the right type of gap, wait for confirmation, and manage risk properly. This strategy works best in highly liquid forex pairs and during the Sunday market open.