Hey Guys,
This Sunday (2012-05-06) EUR/USD opened at 1.3011, 71 pips below last weeks close of 1.3082. This is the largest weekend gap on EUR/USD since November 25th 2011. Whenever the Forex market opens with a large gap I get a barrage of emails about gap trading in Forex.
The conventional wisdom in Forex is that gap trading is highly profitable and easy. In this post I take a look at just how reliable and easy gap trading is.
What Is Gap Trading?
Gaps are empty spaces between the close of one candle and the open of the next. In Forex gaps are not very common and they usually only occur at market open on Sundays. These gaps occur between a pairs close price on Friday and it’s open price on Sunday.
Stock and commodity traders have been exploiting gaps for decades. Since the stock market closes each day gaps are much more common. The concept behind gap trading is that price will always try to fill the gap. This may sound illogical but there are some logical reasons for price to fill gaps in the stock market. Generally when price gaps there is no support and resistance in the gap area. This means that price has free room to move inside the gap.
Over the past few years people have started trading Sunday evening gaps in Forex. The concept is the same, gap traders think that price will always fill a gap.
Does Price Always Fill The Gap?
Technically speaking price always fills the gap, but this doesn’t really mean anything. Every Sunday gap seen this year has been filled but one trade moved 306 pips on the opposite direction before the gap was filled two weeks later. Another gap was filled within two days but the price move 87 pips on the opposite direction before returning to fill the gap.
So even though gaps are almost always filled trading gaps in not always viable.
A Closer Look at Gap Trading
I have compiled statistics in order to analyse the profitability of gap trading. The statistics are of gaps in 2012 on the EUR/USD pair.
The System
To compile these statistics I needed a basic gap trading system. For the purpouses of this analysis I decided to use a very basic system.
Pairs: EUR/USD
Target: Size of gap.
Stop: 50% of target.
Entry: Provided the gap is 20 pips or wider trades are entered as soon as the market opens on Sunday.
Exit: As soon as target or stop is hit.
Broker
For the analysis I used my main broker GFT Forex. Since the Forex market has no central exchange there is no official open or close time in Forex. This means that gaps may appear different dependant on your broker. This could lead to different results than the ones below.
Results
DateGapCloseOpenTargetStopP/L
+45
| 2012-01-08 | 22 | 1.2715 | 1.2693 | 22 | 11 | -11 |
| 2012-01-14 | 45 | 1.2679 | 1.2634 | 45 | 22 | 45 |
| 2012-01-22 | 53 | 1.2930 | 1.2877 | 53 | 26 | 53 |
| 2012-02-05 | 43 | 1.3156 | 1.3113 | 43 | 21 | -21 |
| 2012-02-19 | 42 | 1.3138 | 1.3180 | 42 | 21 | -21 |
| 2012-03-11 | 20 | 1.3123 | 1.3103 | 20 | 10 | 20 |
| 2012-04-01 | 25 | 1.3335 | 1.3360 | 25 | 12 | -12 |
| 2012-04-22 | 27 | 1.3210 | 1.3183 | 27 | 13 | 27 |
| 2012-05-06 | 71 | 1.3082 | 1.3011 | 71 | 35 | -35 |
Five out of the nine trade were losses. Best case scenario, trading gaps using this system would give you a 50% chance of winning a trade. Win rate aside, the system is profitable by +45. This is attributed to the win loss ration of 2:1.
These stats show how unreliable gap trading can be. This year we have had nine gaps, eight of those gaps have been filled and one remains unfilled. The table below shows you the floating pip loss you would have needed to endure for each gap to close.
DateGapCloseOpenTargetMax Float
| 2012-01-08 | 22 | 1.2715 | 1.2693 | 22 | 29 |
| 2012-01-14 | 45 | 1.2679 | 1.2634 | 45 | -10 |
| 2012-01-22 | 53 | 1.2930 | 1.2877 | 53 | -3 |
| 2012-02-05 | 43 | 1.3156 | 1.3113 | 43 | -87 |
| 2012-02-19 | 42 | 1.3138 | 1.3180 | 42 | -306 |
| 2012-03-11 | 20 | 1.3123 | 1.3103 | 20 | -0 |
| 2012-04-01 | 25 | 1.3335 | 1.3360 | 25 | -15 |
| 2012-04-22 | 27 | 1.3210 | 1.3183 | 27 | -2 |
| 2012-05-06 | 71 | 1.3082 | 1.3011 | 71 | -101 |
Three of these nine trades required a floating loss of more than -50 pips before the gap was filled. It is illogical to leave a trade open for -87 pips in the hope of making 43 pips when the gap is filled. One of the trades had a -306 pips floating loss and the one that is currently has had -101 pips. So even though most gaps are filled some require you to suffer large floating losses before being filled.
Is Gap Trading In Forex Profitable?
In my opinion gap trading isn’t a viable in Forex. However, I have only tested one pair with four months worth of data. To be definitive I would need to test at least five pairs with one year of data. I might do this in future but at the moment it is more important to address the flawed wisdom in the Forex community.
GAPS ARE NOT ALWAYS FILLED QUICKLY!
Yesterday I was asked on my blog if I considered shorting EUR/USD risky because there was an unfilled gap above my short. If I see a good trade I wont let an unfilled gap keep me out of the market. The statistics make it clear that gaps are not always filled quickly, so they should not impact my trading decisions.
I think the prevailing wisdom about gap trading in Forex is wrong. While it might be possible to make some profit trading gaps it is not as easy as people suggest. So next time somebody tells you that the price has gapped so you should trade the fill, tell them that gap trading is a roll of the dice.
Edgar Ng
Thanks nick.
Nick
Thanks for reading Edgar.
chinonso patrick
Nice analysis,thanks Nick.<.
Nick
Thanks for reading and commenting Chinonso.
Bruce Lanphar
I trade gaps every Sunday that the market offers a viable one to enter. Favorite pair would be the AUDUSD. I rarely enter at the open but wait to see if gap is going to widen as many did this past Sunday. Because of the election volatility I exited most of my gap trades well before they closed. I had 4 trades and made 200+ pips after closing my last trade early Tuesday morning.
Nick
Do you trade many EUR/USD gaps? they seems to be doing pretty awful this year. I never said definitively that gap trading is not profitable. With different strategies gap trading can be profitable. I am just trying to dispel the myth that gaps always close quickly because they don’t.
Johnny
It would make since that the EUR/USD gaps are not doing very well. My guess is that non of the EUR denominated pairs are. If you are going to do gap trading then I would recommend reading lots of news on the weekend.
You want to be able to stay out of a gap trade that has strong fundamentals driving it.
With everything going on in Greece my guess is that a lot of the gaps for the EUR have not closed as well as they usually do.
Nick
Bruce, can you give a brief outline of your strategy? I just looked at AUD/USD gaps for the last 12 months and several of them have significant floating losses if traded from open.
Do you wait for the gap to widen and then enter when the price moves back into the gap?
Leigh
I have read the theory, your work on the facts is extremely interesting, a most interesting analysis. Thank you
Nick
Thanks Leigh.
jeffthompson
Recent gaps had me wondering too.
Nick
Yeh, there has been a few recently. I think I might take a look at a few more pairs and expand on this post.
peter cham
Thanks Nick.
Nick
Thanks for reading Peter.
DolphinTrader
Awesome Nick! Interesting analysis! Thanks!
Nick
Hey DolphinTrader, glad your enjoyed the post. I am guessing this answers your question from yesterday?
Rjohnston4x
Hi Nick, thanks for yet another great article. I have a question that relates to trading gaps in a slightly different way: Is it reasonable to surmise that, for example, a downward gap represents a price level at which there were sellers, but no buyers whatsoever(until the price which represents the other side of the gap). If this were reasonable would this level not be one in which there was a large imbalance between supply and demand, meaning if price returns to this area a reversal is likely to occur? With thanks, Richard.
Nick
This is a very good question but I am afraid I cannot answer it now. I think your theory has some validity but to give you a definitive answer I will need to do some research on recent gaps.
I will take a look tomorrow and get back to you.
Dean
Hi Nick, Worthy clarification and a good question by Rjohnston4x. If he is correct, then gaps may offer S/R zones (a more traditional Japanese Candlestick viewpoint). Personally, I generally avoid the Sunday open and ‘gap’ trading. Thanks again, Dean
Nick
I agree, it is a good question, I will look into it.
Andrebs95
I think it is worth to trade if you manage your entry & exit with candles in 1h / 4h tf
Nick
Perhaps it is but you would need to exit early a lot of the time. Maybe targeting 50% of the gap is a better idea.
parksey
Hey Nick,
Thanks another great post explaining Gap trading, not somthing I have looked at and probably will not bother looking at
Keep up the good work
Nick
Hey Parksey, thanks for reading and commenting.
Brucelanphar
I trade GAPs but primarily use the GAP as part of the over all trading scenerio and often do not enter the trade until sometime Monday or Tuesday on rare occasions, while waiting for price to reach likely support /resistance area before entering.
sudhir
My last question was not articulate. All I wanted to know is: with 400-500 pips target each month, if you get a trade with a stop-loss of 100 pips and a target of 400 pips, are you done for the month with just one trade?
Nick
Probably not. I will still trade, I would not like taking an entire month off.
Jude
Great article, well written and helpful, thanks. Will avoid.
Jerry
Thank you Nick for this insightful article. I was intrigued, somewhat, with the idea of weekend gap trading. I now believe it is just too risky, for me anyway. THX
Sanjeewa
Thanks nick, very intersting
Michael
What happens if I have open trades at close of forex market on Friday. Will gap (if it happens) be an advantage to me or a disadvantage?
Nick
In the current market conditions it is a big gamble. A gap the wrong direction could wipe out your account so I wouldn’t recommend it for the current market.