The “Gaps Are Always Filled” Myth

Price gaps do represent a reliable trading opportunity and require a strong understanding of money management and risk control. Gap trading as any other trading strategy allows for traders to develop misconceptions. One of the biggest misconceptions is that gaps “are always filled”. Even though gaps are filled in several occasions, gaps may not be filled every single time.

The markets are not constant and they tend to change abruptly. A gap represents an irregularity in the forces of demand and supply and they can be expected to happen in highly volatile and in low volume periods.

A gap pattern provides us with information regarding the current market conditions which allows us to forecast future price action. However, it is important to remember that there is always risk involved and that not every gap trade will be profitable or will always get filled.


Trading Ideas for Market Gaps

Trading a gap by attempting to capture 50% to 75% of the total size of the gap: gaps are price patterns created by a sudden change in the beliefs of the market participants expressed through their trades. A professional approach to trading gaps would be setting realistic profit targets that attempt to capture 50% to 75% of the size of the gap. This will permit for the trader to still capture profits if the gap is only partially filled.

Utilizing measuring gaps to calculate profit target levels: Measuring gaps tend to appear in the middle area of a major trend. This allows the trader to calculate the size of the continuation of a trend and find appropriate profit targets for their trades.

Detect any major price pattern formations previous to the gap appearance: Price patterns play an important role in gap trading. The patterns previous to a gap can provide us with vital information regarding the current gap such as: the potential profitability of the gap, the meaning of the gap, and even the likeliness for the gap to be filled during a correction.

Money & Risk Management Needed for Trading Gaps

The effective implementation of risk mitigation and money management techniques is crucial for trading market gaps as these can often lead to volatile and uncertain market conditions.

Scaling out of a gap trading opportunity: utilizing more than one take profit level or “scaling out” is an advanced money management techniques which allows you to secure partial profits while still being in a price move. For instance, if a gap is 100 pips, a trader can create one take profit to close 25% of the trade after price reaches 25 pips, and close the rest of the trade as price reaches 75 pips.

Establishing realistic stop loss & take profit target levels: as in any other trading opportunity, finding proper stop loss and take profit levels will be critical for successful trading. The combination of technical analysis, gap trading rules & tendencies, and effective money management needs to be applied when selecting stop loss and take profit levels.

This trade represents a high probability gap trade as several technical indications are found to support the filling of the gap.

Conclusion: Are Price Gaps Right for Everyone?

The first step to defining whether or not gaps are appropriate for your investing approach is to understand the type of trading you will be performing. Gaps are short term trading opportunities and are more likely to be profitable in lower timeframes such as the four hour and one hour charts.

Gap trading requires the investor to perform effective technical analysis, employ efficient trading execution and management, and the development of a risk control plan. This will allow the trader to filter the low probability from the high probability trades.

Remember, it is not the quantity of your trades that truly matters; it is the quality.

Jose Molina
Executive Director
Vertical Forex