A very important point to realize is that once Forex gaps start to fill, this process will rarely stop as there are no immediate supports or resistances to prevent it. Gaps are normally caused in Forex Trading by the speculative small trader who exhibits more irrational exuberance than the large institutional investor. Here is a basic gap trading system developed for the forex market which uses gaps trading to predict retracements to prior price levels.
The trade must always be in the direction of the price. The currency must then gap, perhaps over the weekend, significantly above or below a key resistance level as shown on the 60-minute chart before retracing to its original resistance level. As a result, the gap would then appear to be filled and the price has returned to its prior resistance which has now become its new support. You must then wait until you can clearly identify a candle that signifies the continuation of the price in the original direction of the gap. This action helps ensure that the support has remained intact and presents an excellent entry condition for a new trade with a very good risk to reward ratio.
In addition, you are always well-advised to place a stop which, in this case, should be positioned just below the new support level by at least 20 pips. Your open your new entry point about 20 pips in your chosen direction in order to provide some order of protection against fakeouts. Finally, you should select a target level to match close to the gap-end. This Forex trading strategy also complies with the Forex concept of trading in the opposite direction to that of the gap.
However, gap trading is not commonly used by Forex traders because gaps rely mainly on a market close. As the Forex Market never shuts except at the weekend, gaps generation is much rarer. However, although you may think that this presents too few chances to trade gaps, you must realise that Forex gap trading is associated with a very high Forex success rate in the order of 85%.
A good gap trading strategy works for all types of gaps except many gap traders usually dismiss those smaller than 15 pips in size. They also tend to prefer trading just the major currency pairs. The main rule to gap trading is quite simple. Whichever way the gap is growing, you open a trade in the opposite direction. This technique has a proven track-record of astonishing 85%.
In other words, if the gap is rising, sell short otherwise if it falling, buy long. You will be surprised how often this simple strategy works and it could provide you with the foundation on which you can successfully build your Forex trading.