One of our readers recently asked: how to trade gaps? When trading candlestick charts on iq option, you will occasionally notice a space that occurs between two candles. That is, the open, close, high and low of the candles do not overlap each other. This space is aptly called a gap.
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Overview of the gap
This is simply a blank space that appears between two candles on the chart. It represents a sudden price change during periods where no apparent trading takes place. Normally, this occurs between one day's close and the other day's open. However, it can also occur during the day. For example, after a significant news release where prices suddenly change.
There are two types of gaps. The up gap develops when the low price at the close of the session is higher than the high price of the previous session. The down gap on the other hand develops when the high price at the close of the session is lower than the low price of the previous session. Let's talk about how to use gaps!
How to trade gaps on IQ Option
How to trade morning gaps
Price gaps rarely form on intraday charts during the ongoing session. Of course, they may occur if there is significant news or market participants react sharply to some macroeconomic data. At such a time, we can say that the gap itself is at the same time a price slide between candles.
Morning gaps are those most commonly found in equity markets. The name obviously derives from the time at which the pattern is identified. It is logical that the opening share price does not have to be equal to the closing price of the previous session. This is how the most common gaps are formed. In trading, we use morning gaps just like any other price gap.
Using gaps as support/resistance
Once a gap develops, the space created forms a support/resistance range. In the example above, a down gap is created. You should expect that once the price rises and enters this range, it will start falling again.
Most IQ option traders refer to this support/resistance range as a gap test. This means that at a later time, this gap eventually gets filled where prices fluctuate up and down within this range.
Using gaps to trade a trend
In the example above, you'll notice that a gap develops along with the uptrend. This type of gap is a runaway gap. These are created due to increased interest in the underlying asset.
For example, bulls might have thought that the trend is exhausted. However, price retracement doesn't happen. This results in the buyers suddenly jumping into the market resulting in a sudden price spike.
This gap can also be the result of a significant news release which results in a sudden change in prices.
The good thing about runaway gaps is that they develop along with the trend. Once you see this type of gap, your trade position should be along the direction of the trend.
How can gaps be prevented in trading?
Some people wonder how to trade gaps. Believe me, it is equally popular to consider how to avoid trading gaps in financial markets. Price gaps, particularly the morning gap, can prove problematic. They sometimes cause losses and even excess losses.
Imagine that just before the weekend you opened a EURUSD buy position at 1.0700. On Friday evening the last available quote is 1.0730, meaning your position makes money. You may have even managed to move your defensive stop-loss order to the entry-level of 1.0700, so theoretically you should not lose on this position. On Sunday night the market opens at 1.0520, in which case your broker can automatically close your position at a loss because the market has opened beyond your stop-loss order.
For long-term traders, gaps are not such a problem. For day traders, they are often the reason for closing trades overnight or over the weekend in the case of the foreign exchange market. It is very important to be aware of these nuances as they can be very costly.
Gaps are quite rare. But when they occur, they offer excellent short term trading opportunities. Now that you know how to trade gaps, try them out on your IQ Option demo account today. Share your results in the comments section below.
Good luck!