Typ of Gaps in Forex Market

An opening outside the previous session's range generates what is termed a price gap.

Price gaps, as plotted on bar charts, are very common in the currency futures market because though 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 in the futures market between two days' price ranges.

There are four types of price gaps: common, breakaway, runaway and exhaustion.

Common Gaps

Common gaps have the least technical significance of all types of gap. 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 either in relatively quiet periods or in illiquid markets. When price gaps occur in illiquid markets, such as those of distant currency futures expiration dates, they should be completely ignored. The entries for distant expiration dates in currency futures are made only on a closing basis and do not reflect any trading activity. One should avoid trading 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 it that, "Gaps must be filled." Common gaps are short term. When currency futures open higher than the previous day'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 and usually at the end of long consolidation periods, though they may also appear after the completion of some chart formations that tend to act as short-term consolidations. Breakaway gaps signal a brisk change in trading sentiment and occur on increasingly heavy trading. Traders are understandably frustrated by consolidations which are rarely profitable. Therefore, any breakout from a slow moving market is warmly embraced by 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 either during the breakout or for the duration of the subsequent move. In time they may be filled during a new move on the opposite side.

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 pace of price movement on either side of the runaway gap should be similar, you also have a time frame for the duration of the trend.

Exhaustion Gaps

Exhaustion gaps may occur at the top or bottom of a formation when trends change direction in an atypically fast manner. There is no consolidation next to the broken trendline: The trend reversal is very sharp through a bullish move, and 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 simply does not exist, then 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.