Gaps are areas on a chart where there is no market activity. A gap can indicate a number of happenings—support, resistance, topping, and market momentum—and should be examined carefully by all traders.
A gap forms when a currency pair trades through a single price or a range of prices without a transaction. If, for example, the GBP/USD pair was to fall from 1.5050 to 1.5045 in a single tick, then a gap of 5 pips would exist between the two pairs.
The following chart shows a gap:
There are several different types of gaps:
Ordinary Gaps
Ordinary gaps are those which occur in everyday trading. Generally, an ordinary gap provides some of the weakest support and resistance since it is not part of a large market movement. Ordinary gaps are most often found in short-term trading cycles on 1-10 minute bar charts, at the open or close of a major trading session, or on the Sunday night (New York time) following the Tokyo market open.
Breakout Gaps
A breakout gap occurs after the price moves through a major support and resistance line. A breakout gap is usually confirmed with higher than average volume and a large price movement in a short period of time. The breakout gap is most often to be found following a trend line break; thus, traders should be sure to mark the gap for future support and resistance.
Exhaustion or Weakness Gaps
Exhaustion gaps, also known as weakness gaps, occur when a currency is in a clear up or down trend of serious magnitude. When the gap closes on the other side, it’s usually part of a major up or down leg that kicks off many large, buying or selling bars. Typically, an exhaustion gap serves as an indicator that the market is soon to reverse, and since the gap is so high or so low on a chart, it is quickly filled in and provides very little support or future resistance.
What you need to know about gaps:
- Strength in a trend line – A gap often serves as strong support or resistance as orders that were in place before the gap have not been filled. If market sentiment was bearish at the time of the gap, and the price moved down to create the gap, then expect plenty of selling interest as the price rises to close the gapped area.
- Confirmation – A gap can serve as strong confirmation of a broken trend. When the price gaps through a support or resistance line, the next few bars will often run in the direction of the gap. A bull gap can start a bullish uptrend whereas a bearish gap will start a bearish trend.
- Ordinary gaps are so-so – Gaps aren’t always worth watching. If a pair jumps from 1.0000 to 1.0002 to skip the 1.0001 value, then the gap really doesn’t have much importance. If, however, the gap occurs often at this level, then know that it is building up as serious future support and resistance.
Now that you have a handle on gaps, let’s proceed to triple tops and bottoms, a very well-known and recognized chart pattern.
