There’s a common term used by traders: “filling a gap”
It’s referring to a way of profiting from the markets after the price has suddenly gapped in one direction or another.
What I’d like to show you here is the right way to profit from this little trading trick.
And I’ll show you the wrong way – so that you’ll know which “gaps” to avoid.
What is a gap?
A gap is an empty space on a price chart between one trading period and the next. This happens when there’s a big difference in prices between two periods, and the price has moved so fast that no trading has occurred in the price bracket between where one candle finishes and the next one begins.
Gaps generally tell us that something is afoot – such as some economic announcement has come out with unexpected news, or that some political development has spooked investors.
Gaps are a great irritation to traders if you have an order placed somewhere within that gap. Either your trade won’t be opened until some distance after the level you requested. Or your trade won’t be closed at the right level – leaving you with a smaller profit or a larger loss that you’d expected.
However, gaps can be used in a traders’ favour if we understand about “filling gaps”.
Closing the window
Sometimes you’ll hear traders say that the market hates a vacuum and will always “fill a gap”. Or, in Japanese candlesticks, a gap is sometimes called a window, and the Japanese would say that the market is “closing the window”.
The theory is that when a price has gapped, it will later retrace and fill that gap.
Take a look at the chart earlier in this letter – see how the price went back and “filled” the gap.
So, if this is the way that prices behave, can we use a strategy to profit from these “fills”?
Unfortunately, it’s not that simple.
The truth is that gaps are not always filled. Some will be left hanging open for days… weeks… months… or even years.
So, how can we filter out the gaps that are more likely to get filled?
Mind the gap
There are different types of gap that occur on our charts, and if we want to take advantage of gaps, we’ll need to understand them a bit better.
Breakaway gaps: these occur at the end of a period of consolidation, or at the beginning of a new trend.
Continuation gaps: these occur in the middle of a trend, as traders confirm the current sentiment of the value.
Exhaustion gaps: these occur near the end of a price patter and signal a final surge of interest in achieving new highs or lows. This usually indicates amateur traders jumping on board at the end of a story.
Common gaps: these don’t really fit in with any particular story like the other types of gap do. They will usually sit within the normal trading range, and might be caused by a piece of news.
Which gaps will fill?
If we’re interested in trading gaps that fill, the ones we should be on the lookout for are exhaustion gaps and common gaps.
In the case of a breakout gap or a continuation gap, the price will often be moving quickly on, and won’t be looking to revisit these old levels any time soon.
However, common and exhaustion gaps will often fill within a few candlesticks, and this “filling” happens for two good reasons:
First, the sudden jump that the price took up or down was probably caused by misplaced optimism or pessimism, which was likely to be corrected.
And secondly, a market gap leaves no areas for support or resistance within it, so if the price retraces, there is no obvious level for it to stop until it has closed that gap.
Profiting from the gap
Okay, so let’s say that we’ve found a common gap, and we’re anticipating that gap being filled …
Rather than risk our money on the hope that the price will retrace and fill that gap, we’re safer to wait until it has filled the gap and resumes in the direction of the trend.
If you’re looking to profit from these kind of retracements, it’s important to remember a few key points:
• Prices will not always fill gaps.
• Wait for the right kind of gap.
• Trade in the direction of the trend.
• Look for technical confirmation to enter the trade.
By knowing these rules, if you’re looking for retracements in the markets to trade from, you’ll be better place to hunt out the very best trading opportunities.
