Wednesday, April 22, 2015

Gaps


An opening outside the previous day's or other period's range generates
a price gap.
Price gaps, as plotted on bar charts, are very common in the currency
futures market. Although currency futures may be traded around the clock,
their markets are open for only about a third of the trading day. For instance,
the largest currency futures market in the world, the Chicago IMM, is open for
business 7:20 am to 2:00 pm CDT. Since the cash market continues to trade
around the clock, price gaps may occur between two days' price ranges in the
futures market.
There are four types of gaps: common, breakaway, runaway, and
exhaustion.
Common Gaps
Common gaps have the least technical significance of all the types of
gaps. They do not indicate a trend start, continuation, reversal, or even a
general direction of the currency other than in the very short term. Common
gaps tend to occur in relatively quiet periods or in illiquid markets. When price
gaps occur in illiquid markets, such as distant currency futures expiration
dates, they must be completely ignored. The entries for distant expiration
dates in currency futures are made only on a closing basis, and they do not
reflect any trading activity. Never trade in an illiquid market because getting
out of it is very difficult and expensive. When gaps occur within regular


trading ranges, the word on the street has been that, "Gaps must be filled.".
Common gaps are short term. When currency futures open higher than
yesterday's high, they are quickly sold, targeting the level of the previous
day's high.
Breakaway Gaps
Breakaway gaps occur at the beginning of a new trend, usually at the
end of long consolidation periods. They may also appear after the completion
of some chart formations that tend to act as short-term consolidations.
Breakaway gaps signify a brisk change in trading sentiment, and they occur
on increasingly heavy trading. Traders are understandably frustrated by
consolidations, which are rarely profitable. Therefore, a breakout from the
slow lane is embraced with optimism by the profit-hungry traders. The price
takes a secondary place to participation. As always, naysayers follow the
initial breakout. Sooner rather than later, the pessimists have no choice but to
join the new move, thus creating more volume.
Breakaway gaps are not likely to be filled during the breakout and for
the duration of the subsequent move. In time, they may be filled during a


new move on the opposite side.

In Figure 5.34., the currency futures trades sideways in a 100-pip range
between 0.6550 and 0.6690 for a period of time. A price gap between 0.6690
and 0.6730 signals the breakaway from the range.




Signals for Breakaway Gaps:
1. A breakaway gap provides the price direction.
2. There is no price objective.
3. Increasing demand for a currency ensures a solid move on good
volume in the foreseeable future.
Runaway Gaps
From a technical point of view, runaway, or measurement, gaps are
special gaps that occur within solid trends. They are known as measurement
gaps because they tend to occur about midway through the life of a trend.
Thus, if you measure the total range of the previous trend and extrapolate it
from the measurement gap, you can identify the end of the trend and your
price objective. Since the velocity of the move should be similar on both sides
of the gap, you also have a time frame for the duration of the trend.
Trading Signals for Runaway Gaps
1. The runaway, or measurement, gap provides the direction of the


market. As a continuation pattern, this type of gap confirms the health and
the velocity of the trend.
2. Volume is good because traders like trends, and confirmed trends
attract more optimism and capital.


3. This is the only type of gap that also provides a price objective and a
time frame. These characteristics are also useful for developing hedging
strategies.
Exhaustion Gaps
Exhaustion gaps may occur at the top or bottom of a formation when
trends change direction in an atypically quick manner. There is no
consolidation next to the broken trend line: The trend reversal is very sharp
through a bullish move, looks a lot like a measurement gap. So traders buy
the currency and stay long overnight on that assumption. The following day
the market opens below the previous low, generating a second gap. If the
second gap is filled or does not even occur, the trading signal remains the
same. Traders do not have to get caught badly in this exhaustion gap. A
sudden trend reversal is unlikely to occur in an information void. Some sort of
identifiable event triggers the move—maybe a government fall or a massive
and well-timed central bank intervention. Therefore, traders should at least
be warned.





















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