Exhaustion gap definition&trading strategy

Exhaustion gap definition&trading strategyExhaustion Gap Definition & Trading Strategy

Exhaustion Gap Definition

An exhaustion gap comes at the end of an impulsive move. The exhaustion gap has an abnormal pickup in volume and then reverses sharply. An exhaustion gap occurs after an earnings announcement or news release. This final blow off brings enormous public attention and increased trading activity. This event provides professional traders and institutions the opportunity to close out large positions. This mass exodus of the big players causes the sharp reversal in the stock, because after the public gets in, there is no one left to hold the bag. Exhaustion gaps can occur in both up and down trends.

Exhaustion Gaps Trading Strategy

Exhaustion gaps can be one of the most profitable setups to trade in the market. The first component of an exhaustion gap is climatic volume. Secondly the first candle in the setup should close off its high. This is a sign that the stock is tired and is losing its upward momentum. If the next bar closes below the first bar, there is good odds that an exhaustion gap is in play. A stop can be placed above the high of the first bar, and the rest is history. The stock should immediately begin to fall precipitously without any retracements. The move down should resemble a falling knife.

Exhaustion Gap Charting Example

Below is an example of an exhaustion gap from BTU. The stock had run straight up from $76 to $86 and then had a sharp pickup in volume. This final move up, quickly reversed and the stock dropped 6 points in 2 days.

Exhaustion gap trading strategy for reversals

Exhaustion gap trading strategy for reversalsExhaustion Gap Trading Strategy For Reversals

Imagine waking up to find that your favorite stock has gapped up overnight and given you a windfall profit. Is it time to grab your profits and go? Is it time to reverse your bias and sell short the stock?

If the gap is an exhaustion gap, then the answer is probably yes.

An exhaustion gap is found after a trend is exhausted. In a bull trend, an exhaustion gap is an up gap that represents the last climatic buying. The gap represents a surge of ultra-late buyers. Having no more fools to buy after them, the trend is ready for reversal. Hence, the exhaustion gap trading strategy is a trend reversal play.

Rules For Exhaustion Gap Trading Strategy

An exhaustion gap occurs with extremely high volume. I have a standard method for finding extremes using Bollinger Bands. In this case, we want to find extreme volumes, so I applied a 233-period Bollinger Band with 3 standard deviations using the volume bars. Any volume bar that exceeds the upper Bollinger Band is extreme.

Bullish Reversal

A bear trend

A down gap with extreme volume (as we defined above)

Gap closed within five bars

Bearish Reversal

A bull trend

An up gap with extreme volume (as we defined above)

Gap closed within five bars

Exhaustion Gap Trading Strategy Examples

Winning Trade Bullish Reversal

This is a daily chart of C. R. Bard, Inc (BCR). The lower panel shows the volume. The orange line is the upper line of a Bollinger Band (233,3) for finding extreme volumes.

There was a clear bear trend. You can define the market trend using your own trading methods. But generally, the longer the trend, the more likely a reversal trade will succeed.

This down gap made a new low with extreme volume. The bullish bar that followed the gap showed strong bullish pressure. Price closed the gap within 3 days and we bought as soon as price closed the gap.

A triangle developed after our entry. Using the triangle measuring rule gave us a good first target. (dotted arrows)

While this exhaustion gap caught the market low, the timing was not great as price meandered sideways after our entry. However, BCR did not make a new lower low after the gap, which confirmed that the gap was exhaustive.

Losing Trade Bullish Reversal

This is the daily chart of Zions Bancorporation (ZION). It shows a gap that was not exactly exhaustive.

Every reversal trade needs a trend to reverse. In this case, we had a bear trend.

This down gap looked like an exhaustive gap with extreme volume. ZION filled the gap on the fifth day, which makes it less impressive than the BCR trade which filled it on the third day. For exhaustion gaps, the sooner it is filled, the more likely we have a reversal.

Instead of reversing the trend, price fell and made a new low, stopping out all reversal traders.

While this trade failed technically, it is somewhat exhaustive as it halted the down trend. No analysis is perfect. In this case, we might have mistaken a common gap for an exhaustive gap.

Review Exhaustion Gap Trading Strategy

There are four types of gaps including common, breakaway, runaway, and exhaustion. The exhaustion gap is distinctive because it gaps further with higher volume. It is easier to label an exhaustion gap. Hence, it is a great basis for trading a reversal.

However, in the exhaustion gap trading strategy, the safe stop-loss level is the extreme low of the trend for bullish reversal. (Reverse for bearish reversal.) Placing a tighter stop will expose us to whipsaws which are common after price fills the gap.

If you are uncomfortable with large stops, wait for bullish chart formations or bar patterns before entering. These entries will offer a tighter stop-loss. (Like the triangle formation in the winning example.) However, you will miss some of the best reversals that take off without looking back.

High volume is a sign of trend exhaustion even without gaps. Look out for bars with abnormally wide range bars with high volume. If they have no follow-through, you might have a reversal trading setup.

Take a look at these two books for more gap trading ideas:

Technical Analysis of Gaps: Identifying Profitable Gaps for Trading

Stock Gap Trading Strategies That Work (Connors Research Trading Strategy Series)

Gap trading

Gap tradingGap Trading

What are Gaps in trading and how to trade Gaps

Gaps in trading are a common phenomenon and very commonly occurring in stocks. A gap is formed when the opening price for the day is higher or lower than the closing price of the previous day. A gap is nothing but an empty space between the closing price of the previous candle and the opening price of the next candle.

The chart below is an example of a Gap formed on NZDUSD. Here, we can see the difference between previous candle’s closing price and the next candle’s opening price . indicating a very bullish sentiment.

Why are Gaps formed?

Gaps are formed when there is an extreme sentiment in the market and when bulls or bears overwhelm the other. Gaps in the forex markets can often be seen during important news events . or on the first price candles of the week when the market is closed during the weekend. Gaps can be easily distinguishable on Candlestick charts or OHLC bar charts. (. Read more about Forex Trading the News )

Gaps are identified individually as a Down Gap and an Up Gap .

A down gap is formed with the opening price is lower than the closing price of the previous day. An up gap is formed with the opening price is higher than the closing price of the previous day.

The chart below is an example of an up gap and a down gap .

When you hear about Gaps, there is a common saying that “ Gaps are meant to be filled ”. In other words, if a Gap is formed, traders believe that price always comes back to fill that Gap. This philosophy needs to be taken with a pinch of salt. For example, when a Gap is formed, price can almost immediately or within the span of a few hours can reverse and fill the gap. And at times it can take weeks or months for a Gap to be filled.

The above chart shows how the Gap that was formed on 12 th of July 2014, was filled some weeks later around 23 rd July.

The next chart below shows another example of a Gap that was filled within a few days.

Therefore, while it is true that gaps are meant to be filled, there is no saying in how long it could take for the gap to be filled.

Types of Gaps

Gaps can be classified into the following four types:

Break away Gap

Run away or Continuation Gap

Common Gap

Exhaustion Gap

Break away Gap . A break away gap is typically formed at the start of an uptrend or when price is just coming out of a consolidation phase. It is known as a breakaway gap because price tends to break out from its previous consolidation to establish a new market move. The chart below shows an example of a breakaway gap that was formed right after a prolonged period of consolidation.

Runaway or Continuation Gap . This type of gap is formed within the prevailing trend and is usually said to occur mid way of a trend. When a runaway gap is identified, traders know that the previous trend will continue and trade in the direction of the trend. Trading the continuation or runaway gap is probably one of the safest methods to trade, especially when combined with other trading methods such as support/resistance or trend lines. The chart below shows a continuation gap that was formed in the middle of the uptrend.

Common Gap . This is one of the least important gaps and is formed, as the name suggests, commonly. Common gaps can be formed at any time of the trading session. Common gaps are more likely to be filled within a few price bars and can therefore be used for very short term intra-day trading. The chart below shows a common gap that was formed, notice how quickly this gap was filled.

Exhaustion Gap . Exhaustion gaps are formed towards the end of the previous trend and indicate the last final push in momentum before prices start to fizzle out. Exhaustion gaps are better found with stocks as it is commonly identified with a gap being formed with an unusual surge in volume. In forex however, volume is not a reliable indicator and therefore exhaustion gaps should be considered along with the prevailing trend and possible support/resistance levels. Exhaustion gaps occur within the direction of the previous trend. Example, in an uptrend, exhaustion gaps are identified with an up gap (or down gap if the previous trend was a down trend).

The chart below shows an exhaustion gap being formed after a brief rally. Notice how after the gap was formed, price quickly changed direction and continued to fall.

Gap Trading Conclusion

Gaps . in the forex market are a common phenomenon and depending on the type of Gap that was identified, long or short positions can be taken. If you are not sure about trading with Gaps, gaps can alternatively be used as a confirmation signal . For example, when you notice a runaway gap being formed, you can take a position based on the prevailing trend, knowing very well that run away gaps are formed in the middle of a trend. Gaps can therefore be a helpful way to understand the market sentiment and trade accordingly.

Ninjatrader volume indicator

Ninjatrader volume indicatorTrading with the Volume Indicator:

To avoid the chop in the market, we look for 2 consecutive bars of a given color to confirm the market state. The light colored bars (light green and pink) indicate states of market expansion, or trend continuations. The dark colored bars (dark green and dark red) indicate states of market contraction, or pullbacks. In general, we want to enter trades during a period of contraction (after a pullback), so we can participate in the profits from the trend expansion/continuation. As you can see from the screen shot above, the Volume Indicator is very good at identifying key exhaustion and contraction points in the market.

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Forex trading gaps strategy

Forex trading gaps strategyForex Trading Gaps Strategy

You may or may not have heard of “trading the gap” as a Forex Trading strategy. For those who haven’t, it’s a very simple concept – if a market opens up away from the close of its prior session, it’ll frequently move to close the gap. A true gap is where the market opens above or below the entire range of the prior session, but in reality you can work with ones that open away from the prior close but still within the range. But how does this work in 24hr forex?

SESSIONS EXPLAINED

Although there are markets that close every day and therefore have real gaps, forex doesn’t do this. The only time it closes is on Friday and it reopens on Sunday. So the only real gaps which exist in forex are these weekly gaps and that’s only if the price changes significantly. But you can also create artificial gaps between main sessions. For example, in EURUSD you might choose to chart the London and New York sessions only. This means that each day, you have a period from 3am 5pm EST that you could use as a primary session. Any movement in price that occurs from the close of one session to the open of the following will appear as a gap.

TYPES OF GAPS

Although all gaps are technically the same, the interpretation of each can be very different depending on their location within the broader activity of the market in question. There are three classic types of gaps: breakaway, runaway and exhaustion gaps. A breakaway gap is what it sounds like. The market is range bound and gaps away from this range signaling the potential of the start of a trend. Runaway gaps are basically a continuation of a trend where increased interest in the direction of the trend enters the market and the market gaps in price on open. This can signal that the trend is decent and the market is likely to continue in the direction of the trend. Finally there are exhaustion gaps. These occur after a prolonged trend and are a potential indication that a reversal is imminent. But a gap can also occur within a range bound market too and this type of gap can have a good chance of being closed. The point is that some gaps are better to fade (trade against) and some are better to go with.

STATISITICS

From a statistical basis, gap closes are pretty common. But there is definitely a sweet spot. In a quick 200 day study of EURUSD on the London – New York session I mentioned above, gaps of 1-20 pips are closed 89% of the time. 21-45 are closed 69% of the time, whilst gaps of greater than 45 pips are closed just 20% of the time in the same session. And this is on the premise that the closing price of the prior session is traded again in the new session and so the gap is completely closed. So you can see that EURUSD at least often likes to close its gaps. If you take the time to do the research, you’ll find that there are certainly plenty of other products that also like to close their gaps.

WAYS TO TRADE

Although gaps are often closed, it’s not all beer and skittles from here on in. Think about it for a minute. First of all you should be trying to read the context available to you – a breakaway gap is not going to be one that’s a good idea to trade against for example. Then just because a gap is likely to be closed in the session doesn’t mean you’ll know when it’s going to close. If the EURUSD gapped up 30 something pips and you just sold it immediately, it could go another 100 pips higher and stop you out before turning down to close the gap. So you need to select the right gaps to trade and you need to identify when the market activity is telling you it wants to close the gap. This could be done in any way you chose, but strategies like the Trend Jumper which are built around trade activity are a particularly good choice. Find a suitable gap, wait for the market to test and fail in the same direction as the gap, get an entry signal from your strategy and take the trade.

Gap trading can be great way to trade any market and forex is no exception. But make sure if you’re going to trade in this way, that you take the time to do a little research on your market of choice and select your gap trades based on context and systems forex trading activity.

How to trade gap ups

How to trade gap upsHow to trade gap ups

How to trade gap ups

Gap up can be very profitable if you trade it properly and it is somehow riskier than other patterns. There are different types of gap up that traders use to trade such as exhaustion gap up, initial gap up and gap up. What I wanted to see is if a stock gap up with good volume regardless of the type. It is often safer to buy a stock when the volume is high because the trend will likely to continue. If a stock gap up with low volume, yet it could still go higher, there is a bigger chance that the stock will go down and close the gap.

Gap up is best used as a confirmation trend when you find bullish patterns the previous day. It can be used in combination of bullish engulfing pattern (candlestick), morning star pattern (candlestick), stochastic crossover, macd crossover, triangle patterns, hitting support line, and so on. When you find a stock that is likely to form a triangle pattern as follows, and the stock gap up the next day or a few days after, that is usually a good entry point.

Example 1: Stock CFW

- The stock was in the consolidation area in the period of 2/3/2010 to 3/2/2010 and hitting support level. On 3/5, the stock gap up and almost double in 3 weeks. (Up 92%).

Example 2: Stock PENN

- This stock formed a bullish engulfing pattern (Candlestick Pattern) and hitting support on 2/26/2010, and then it gap up on the next trading day (3/1/2010). It then went up from $23.10 to $27.57 for a 19% gain.

The best swing trading entry and exit signals

The best swing trading entry and exit signalsStay Connected

Most swing traders rely on the basic turning points, indicators that the current short-term trend is about to turn. This is a reliable system, but a few single-session candlestick patterns can enhance every swing trader's timing.

These traditional signs include:

1. Reversal days. The most apparent sign that the trend is ending is when the price begins moving in the opposite direction. However, this needs to be confirmed by at least one additional reversal signal.

2. Narrow-range day (NRD). This is a very strong signal. When the trading range of a session is exceptionally small, that indicates that the current trend may be about to turn. As with all entry/exit signals, this also needs to be confirmed.

3. A volume spike. When volume is unusually high on one session, it indicates a very active struggle between buyers and sellers, something most likely to occur at the end of a short-term trend.

The strongest possible swing trade reversal sign shows up when you see a reversal day followed immediately by an NRD and a volume spike. But even these three reliable reversal signs can be enhanced with a few valuable single-session candlesticks. These include the spinning top, long candlestick, and marubozu. Accompanied by gaps, especially in a running series, the candlesticks make timing of swing trades better than with just the three well-known signals.

Swing Trading Entry and Exit Signals

The figure provides an example of Yahoo (YHOO ) with these candlestick signals highlighted. The spinning top shows up at the top of the uptrend, and indicates a likely reversal in the next few sessions. It's a valuable session pattern because the long upper and lower shadows tell you that neither buyers nor sellers were able to move the price beyond the relatively small trading range. In other words, the existing trend is likely to be at or near the point of exhaustion.

Long candlesticks, as the name implies, are sessions with larger than usual trading ranges. A variety, the marubozu, is a long candlestick with little or no upper or lower shadow. In Japanese, "marubozu" means "with little hair." If you note the placement of the marubozu and long candlesticks on Yahoo's chart, you'll see that they tend to show up at or near the turning points in short-term trends.

Accompanying the valuable candlestick patterns and often confirming them are gaps. When big gaps appear right after important candlesticks, it indicates that whatever the candlestick implies may be particularly strong. It can also signal growing price exhaustion, with likely reversal to follow a few sessions later. The big move toward the end of August is framed by gaps on the way up as well as on the way down. This reverse and fill pattern is revealing and can be interpreted as a lack of momentum to the upside.

Chart interpretation is subjective and hindsight is always perfect. However, in the moment, you can improve timing in a swing trading strategy by being aware of how candlestick patterns confirm what the swing appears to be going through. Candlestick patterns are just one more tool to help you improve your swing trading strategy and the timing of entry and exit.

For day and swing trading setups from the creator of the Hit & Run trading strategy, take a FREE 14 day trial to Jeff Cooper's Daily Market Report. You'll get daily setups with entries, targets & stops as well as intra-day trade alerts and daily market commentary. Learn more .

The long-tail trading strategy

The long-tail trading strategyThe Long-Tail Trading Strategy

The following trading strategy makes use of a specific reversal bar, the Long-Tailed Hammer, which tends to give high probability signals of reversals of the trend. When correctly identified and used in conjunction with a measure of volatility, such as the Bollinger Band. the long-tail candle can be a useful starting point from which to initiate a trade, with a high probability success rate on most major Forex pairs.

How to define?

The long-tailed hammer, the dragon-fly doji, the pin-headed hammer are all names for a specific type of candle which has a longer-than-average range and a shorter - than-average body – sometimes a very small or pin-like body.

This type of set-up, when it occurs at the end of a down-trend, often outside the parameters of the expected trading range is a very strong signal of the exhaustion of that down-trend and possible reversal from bear to bull. The pictures below show examples of such a candle:

The above is a Long Tail hammer which occurred recently on the aussie. As can be seen from the picture it successfully marked exhaustion of the previous down-trend and preceded a strong rally up in the pair.

Another long-tail on the aussie – note how the entire candlestick formed outside the extremes of the lower bollinger-band emphasizing the exhaustion of the down-trend.

Other indicators

Now that we have looked at some examples of long-tails let us look at the other key element of the strategy, the use of bollinger bands.

The Bollinger Band is an envelope around prices. It is calculated by taking the 20-period simple moving average and then marking two lines, one above and other below which sit at 2-standard deviations from the mean. Theoretically prices move within the bands for 95% of the time. This means that when they stray outside the bands there is a high probability they have reached an extreme and will revert to the mean – or in layman’s terms move back inside.

This strategy requires a that the long-tail form at the lower edge of the bollinger band, more specifically that at least 50% or more of the range of the long-tail lies below the bottom line of the band.

How to trade the long tail

I am now going to outline some suggestions as to how to trade the long-tail. These are by no way definitive and individual traders can alter them as they see fit.

Normally traders advocate waiting for confirmation after a hammer candle, with confirmation coming in the shape of a second strong bullish candle, however, the long-tail is such an exceptionally strong reversal signal on its own that I would advocate entering with a long position before confirmation. This also has the added benefit of minimizing risk.

Another obvious place to enter a long position would be the high of the long-tail, and this would be valid, but I also think it could be unnecessarily late and again – depending on stop placement – probably more expensive in cases of failure. Instead I would advocate placing the stop at the top of the body of the long-tail, that is at the level of the close for a green long-tail or open for a red. It is very rare for the market to take off and gap higher so this entry-point takes advantage of that fact.

Stop placement

We have discussed entry but what about stop placement and more importantly stop management?

Normal practice would be to place the stop just below the bottom of the long-tail candle or the equivalent to the average true range away, however, in order to minimize risk and preserve capital I advocate placing the stop at a Fibonacci 76.4% of the range of the long-tail, which means 76.4% down from the high of the long-tail candle. The tighter stop, is again based on the fact that the signal is so strong.

Stop Management

One possible method of reducing risk further is to move the stop up after the first up-day following the long-tail. There are then several possible ways of managing the stop and exiting the trade.

One method involves leaving the stop at break-even and waiting a set number of days before taking profit. 4, 5 and 10 days seem to work well form back-testing, with 10 days sometimes leading to large accumulations.

Using the Bollinger-Band Centre Line

The final method is to use the centre of the bollinger band, that is the 20-day MA and move the stop up using that. This method is illustrated on the long-tail chart from EUR/JPY above and works in the following way:

The trade triggers at the entry-point established above (at the high of the body). The pair rises and the trade begins making money. After the first up-day the stop is moved up to the entry-point at break-even. The exchange rate rises and reaches the 20-day moving average line of the bollinger band – the centre line. If it manages to close above the line, the stop is moved up to the lows of the candle which closed above it (moving stop A in the diagram above). If it does not manage to close above the line the stop is left at break even. If the market rallies but then falls back below the 20-day line, and then rallies once again above it; the stop is moved up to the low of the candle which closed above it as in b) (moving stop B in the pic above). With each break of the 20-day line and recovery rally above it the stop is moved up again locking in more and more profit, until an eventual concerted move down triggers the stop.

Playing the gap

Playing the gapPlaying The Gap

Gaps are areas on a chart where the price of a stock (or another financial instrument) moves sharply up or down, with little or no trading in between. As a result, the asset's chart shows a "gap" in the normal price pattern. The enterprising trader can interpret and exploit these gaps for profit. This article will help you understand how and why gaps occur, and how you can use them to make profitable trades.

Gap Basics

Gaps occur because of underlying fundamental or technical factors. For example, if a company's earnings are much higher than expected, the company's stock may gap up the next day. This means that the stock price opened higher than it closed the day before, thereby leaving a gap. In the forex market, it is not uncommon for a report to generate so much buzz that it widens the bid and ask spread to a point where a significant gap can be seen. Similarly, a stock breaking a new high in the current session may open higher in the next session, thus gapping up for technical reasons.

Gaps can be classified into four groups:

Breakaway gaps are those that occur at the end of a price pattern and signal the beginning of a new trend.

Exhaustion gaps occur near the end of a price pattern and signal a final attempt to hit new highs or lows.

Common gaps are those that cannot be placed in a price pattern - they simply represent an area where the price has "gapped."

Continuation gaps occur in the middle of a price pattern and signal a rush of buyers or sellers who share a common belief in the underlying stock's future direction.

To Fill or Not to Fill

When someone says that a gap has been "filled," that means that the price has moved back to the original pre-gap level. These fills are quite common and occur because of the following:

Irrational Exuberance . The initial spike may have been overly optimistic or pessimistic, therefore inviting a correction.

Technical Resistance . When a price moves up or down sharply, it doesn't leave behind any support or resistance .

Price Pattern . Price patterns are used to classify gaps, and can tell you if a gap will be filled or not. Exhaustion gaps are typically the most likely to be filled because they signal the end of a price trend, while continuation and breakaway gaps are significantly less likely to be filled, since they are used to confirm the direction of the current trend.

When gaps are filled within the same trading day on which they occur, this is referred to as fading. For example, let's say a company announces great earnings per share for this quarter, and it gaps up at open (meaning it opened significantly higher than its previous close). Now let's say that, as the day progresses, people realize that the cash flow statement shows some weaknesses, so they start selling. Eventually, the price hits yesterday's close, and the gap is filled. Many day traders use this strategy during earnings season or at other times when irrational exuberance is at a high.

How to Play the Gaps

There are many ways to take advantage of these gaps, with a few more popular strategies. Some traders will buy when fundamental or technical factors favor a gap on the next trading day. For example, they'll buy a stock after-hours when a positive earnings report is released, hoping for a gap up on the following trading day. Traders might also buy or sell into highly liquid or illiquid positions at the beginning of a price movement, hoping for a good fill and a continued trend. For example, they may buy a currency when it is gapping up very quickly on low liquidity and there is no significant resistance overhead.

Some traders will fade gaps in the opposite direction once a high or low point has been determined (often through other forms of technical analysis). For example, if a stock gaps up on some speculative report, experienced traders may fade the gap by shorting the stock. Lastly, t raders might buy when the price level reaches the prior support after the gap has been filled. An example of this strategy is outlined below.

Here are the key things you will want to remember when trading gaps:

Once a stock has started to fill the gap, it will rarely stop, because there is often no immediate support or resistance.

Exhaustion gaps and continuation gaps predict the price moving in two different directions - be sure that you correctly classify the gap you are going to play.

Retail investors are the ones who usually exhibit irrational exuberance; however, institutional investors may play along to help their portfolios - so be careful when using this indicator, and make sure to wait for the price to start to break before taking a position.

Be sure to watch the volume. High volume should be present in breakaway gaps, while low volume should occur in exhaustion gaps.

To tie these ideas together, let's look at a basic gap trading system developed for the forex market. This system uses gaps in order to predict retracements to a prior price. Here are the rules:

1. The trade must always be in the overall direction of the price (check hourly charts).

2. The currency must gap significantly above or below a key resistance level on the 30-minute charts.

3. The price must retrace to the original resistance level. This will indicate that the gap has been filled, and the price has returned to prior resistance turned support.

4. There must be a candle signifying a continuation of the price in the direction of the gap. This will help ensure that the support will remain intact.

Note that because the forex market is a 24-hour market (it is open 24 hours a day from 5pm EST on Sunday until 4pm EST Friday), gaps in the forex market appear on a chart as large candles. These large candles often occur because of the release of a report that causes sharp price movements with little to no liquidity. In the forex market, the only visible gaps that occur on a chart happen when the market opens after the weekend.

Let's look at an example of this system in action:

Figure 1 - The large candlestick identified by the left arrow on this GBP/USD chart is an example of a gap found in the forex market. This does not look like a regular gap, but the lack of liquidity between the prices makes it so. Notice how these levels act as strong levels of support and resistance.

We can see in Figure 1 that the price gapped up above some consolidation resistance, retraced and filled the gap, and finally, resumed its way up before heading back down. We can see that there is little support below the gap, until the prior support (where we buy). A trader could also short the currency on the way down to this point, if he or she were able to identify a top.

Remember, gaps are risky (due to low liquidity and high volatility), but if properly traded, they offer opportunities for quick profits.

Forex market gap trading strategy

Forex market gap trading strategyForex Market Gap Trading Strategy

A gap or price gap is a scenario where the market opens outside the previous bar or previous days range. They are mainly unanticipated for and if they find you in the market without stop losses then you will be in for a sock. They also very much frequently happen during news releases.

Types of gaps

Common Gaps

This mainly occur due to lack of liquidity in the market. They don’t signify anything. So you should not be fooled by them that there is a reversal or a trend start. Example is wen a market opens at a higher or lower level after a weekend.

This gaps are short term. However as a trader you should be careful to determine whether there are other forces behind the gap before concluding it is a common gap.

Breakaway Gaps

These gaps occur when a new trend is just about to take effect. Is mainly at the end of a long consolidation periods or after the completion of some chart creations that tend to act as short-term consolidations.

Fig.1. Breakaway gaps

Runaway Gaps

These gaps are also known as measurement gaps. This is because they tend to form at the middle life of a solid trend.

Exhaustion Gaps

This is similar to the breakaway gap with the only difference being that it has no consolidation next before the gap forms. Therefore this means that the trend change or reversal is very sharp. If you enter a trade before this gap happens an you have no stop loss then is a matter of seconds you may lose a lot of cash since it doesn’t gives a warning of reversal by consolidating.

How to trade the various types of gaps

For the common gaps the gaps will always get filled. This is because they occur due to activities taking that affect the currencies but the market isn’t traded. So the market opens at a level different from previous. Therefore once you open your market after the weekend and find such a gap then you should open a trade anticipating that the gap will get filled. Then be sure to put your take profit just at the closing of the previous candle.

Fig.2. Placing an order in a common gap.

Notice the trade is opened at the close of the candle after the gap. this methid will give a 100% profit.

With the breakaway gaps you should open a trade in the direction of the gap. That is you should not wait for the gap to get filled. Therefore you can open a long term trade and use trailing stop so that you exit the market when there is a retrace in the trend. The one way to determine that a gap is a breakaway is by looking for the consolidation of market prices just before the gap.

With the runaway gaps the gap provides the direction of the market trend. Therefore they show a continuation of the already existing pattern. Therefore this gap affirms the direction of the trend. Therefore it kind of confirms to the traders that a certain trade is real and true. Hence you can open a trade without fear. by measuring the length and range of the previous section before the gap and extrapolating it, it is possible to predetermine when the trend will end thus when to pull out of an order with your profits.

Forex Gap Trading Video Tutorial

The common forex candlestick patterns that you need to know

The common forex candlestick patterns that you need to knowThe Common Forex Candlestick Patterns that You Need to Know

Common Candlestick Patterns

In the previous chapter, we covered the Japanese candlestick. now it’s time to demonstrate how some simple candlestick patterns can be the catalysts for some explosive moves in the market. When identified correctly, these chart patterns can help traders spot potential market tops or bottoms, and even can signal traders into potential breakouts before they actually happen.

In this chapter we will talk about the most common candlestick patterns that most traders will recognise and incorporate into their technical analysis…

The Double Top

Double top candlestick patterns form after a strong price rally or strong bullish conditions. It is easily identifiable because the double top pattern looks like two mountain peaks that form an M shape on the chart.

The two peaks will generally be reacting with some strong resistance in the market, demonstrating that the bulls cant penetrate that level. The initial bullish wave hits the resistance and bounces straight off it, finding support after a market retracement.

Bulls eventually pick up steam again to push the market back into higher prices where the market retests the resistance level. The bulls dont have enough strength to break through the resistance, and price bounces straight off it again, creating the second peak.

A double top pattern is a classic sign of bullish exhaustion. The double top candlestick pattern generally signals the market is about to tip over. The containment line for the double top candlestick pattern is called the ‘neckline’, and this is where the market found support after the first peak.

The standard way to trade a double top candlestick pattern is to wait for the second peak to form and then short price breaks below the neckline. But as the saying goes, there is more than one way to skin a cat.

Here is an example of a real double top pattern…

The double top candlestick pattern is great for identifying bullish exhaustion and market tops. You can see on the chart above, after a long really this market double topped and broke the neckline, which resulted in a very profitable bearish trade.

The Double Bottom

The double bottom candlestick pattern is really the exact inverse of the double top pattern. It forms after strong bearish moves and has a ‘W’ type shape to it.

A double bottom signals bearish exhaustion and is formed when the bulls start to take control at a specific support level. The bears drive prices down into this support level where the bulls step in and drive prices back higher, this bullish rejection of support creates the first ‘V’ shape trough.

The market finds resistance and the bears attempt to drive prices back down. When the market reaches the support level for a second time the bulls step back in again, driving prices higher creating another ‘V’ rejection shape trough. This final move completes the double bottom candlestick pattern.

The resistance found after the first trough is referenced as the neck line. When prices push higher through the neckline, the double bottom pattern is completed and triggered.

Take a look at this example of a double bottom…

You can see how the market found a support level which the bears just could not punch through. The bulls held their ground here creating the double bounce, then the final push higher.

Long positions are generally triggered once price breaches the highs of the neckline, after the second bounce off support, but as we said before, there are multiple strategies to tackle double tops and bottoms. Just dont get caught up chasing price. have a clear action plan in place.

Double bottoms are great indicators of bearish exhaustion and generally signal the end of bearish trends. Double tops and bottoms are much more powerful when played on the larger timeframes.

Head and shoulders

Head and shoulders are another market exhaustion candlestick pattern. This pattern is most reliable forming after the market has been already been trending in a certain direction for a while.

Let’s take a look at a basic head and shoulders candlestick pattern anatomy that forms on top of a bullish move.

As the name suggests, the candlestick pattern consist of a head and two shoulders. Normal head and shoulder patterns form on top of bullish trends, and just like the double top they signal bullish exhaustion.

The pattern is created when the bulls find a solid resistance level, retrace back and find support which creates the left shoulder. At this stage it’s impossible to tell if a head and shoulders candlestick pattern is forming.

When bulls pick up strength again and fire price upwards punching straight though the last tested resistance, however these higher prices cant be maintained and price collapses back down under resistance as the result of a false break. It’s the false break that creates the ‘head’ part of the candlestick pattern.

After the bulls failed to maintain prices above resistance, they muster their strength and try again. Resistance holds and price falls back to support. This last phase creates the right shoulder and completes the head and shoulders pattern.

The containment line which has been acting as support during the whole process is called the neckline. The traditional way to trade the head and shoulders pattern is to go short when the market breaches the neckline after the signal has formed.

Check out a head and shoulders pattern that formed on a real chart…

You can see how this head and shoulders candlestick pattern demonstrated the exhaustion of the bulls. When the neckline was breached, this market aggressively sold off. Also note how the head and shoulders pattern formed after a strong bullish move.

The Inverse Head and Shoulders

The normal head and shoulders candle pattern signals and communicates bullish exhaustion. If you flip the pattern upside down you get the ‘inverted head and shoulders’ and this inverted pattern signals bearish exhaustion by operating in reverse.

After strong bearish activity; the market runs into support, retraces and finds resistance which creates first phase creates the left shoulder. It’s impossible to tell if the inverted head and shoulders pattern is forming at this point in time.

The bears push the market down; causing a false break, or breakout trap below the recently tested support. When price shoots back up above support it creates the ‘head’ section of the pattern.

The bulls retest the support level. Support holds and price bounces back to the resistive containment line, which is actually the neckline in this candlestick pattern. This also completes the inverted head and shoulder pattern. The classic way to trade this is by waiting for the market to push above the neckline, this triggers long trades.

You can see in the above example how the inverted head and shoulder candlestick pattern demonstrated bearish exhaustion and when the bulls broke the neckline containment, it produced a profitable trade.

Ascending Triangles

Ascending triangles form when the market runs into a resistance level and stalls market movement. Bullish pressure is still strong and continues to build up underneath, compressing prices tighter and tighter with each attempted bounce of resistance.

Generally what happens is the bulls eventually build up enough strength and punch through the resistance level just like in the example shown above.

Important. In some cases the bulls can be exhausted during the formation of the ascending triangle, resistance holds and the market can collapse.

Descending Triangles

The inverse of the ascending triangle, heavy bearish pressure jams into a strong support level in the market. The increasing bearish pressure rejects bullish moves off the support level and compresses price tighter each time.

In the chart above you can see a real example of a descending triangle candlestick pattern. The bearish pressure eventually overwhelmed the support line and produced a profitable short trade.

Important. This isnt always the case; the bears can be exhausted while attempting to break the support level. When the bears are out of steam, the bulls have no resistance and bullish breakouts can occur.

Wedges form when the market stalls in a period of indecision and starts producing higher lows and lower highs consistently. Eventually this HL LH patterns compresses price into the tip of the wedge that inevitably leads to a breakout.

Once price reaches the tip of the wedge, there is a high chance a breakout will occur. Wedges are bilateral, that means they can breakout in either direction. So the classic way to trade wedge breaks is to buy breakouts out the top of the wedge and sell price breakdowns below the wedge.

In the examples shown above, we can see once price was compressed into the wedge tip price broke out either the top or bottom of the wedge pattern. If we traded in the direction of the breakout here we would have caught some nice moves.

Flags form when the market retraces during trending conditions and are used as trend continuation patterns. The counter trend movement creates a small channel, when price breaks the channel in the direction of the trend, the continuation trade is triggered.

Using Chart Patterns with Price Action

Trading chart patterns like the ones discussed in this chapter can be profitable, but we like to combine our price action signals with these charts patterns to add confluence to our trades, creating higher probability trade setups.

In the example above, the chart had formed a double top pattern. A bearish pin bar signal was communicating future bearish price action right on the neckline support.

After price had broken the neckline, the market retested the neckline support as new resistance and produced a breakout trap reverse trade. The double top reinforced our trade setups and our bearish bias.

The chart above demonstrates how an Inside Bar breakout signal got us into the wedge pattern breakout. Because of the Inside day price action signal, we were able to trade this wedge pattern with a tighter stop and produce a higher risk/reward trade.

To learn about our price action signals and how to combine them with chart patterns, check out our advanced Price Action Trading Course .

In the next chapter of our beginners course. We will be looking at some of the price action signals we use to trade.

May 6, 2013 TheForexGuy

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How to understand the three building blocks for trading elliott wave

How to understand the three building blocks for trading elliott waveHow to Understand the Three Building Blocks for Trading Elliott Wave

Talking Points

How To Understand the Basic Pattern How To Understand Corrections vs. Impulses In Markets How To Understand Fibonacci In Relation To Wave Development

“I attribute a lot of my own success to the Elliott Wave approach.”

-Paul Tudor Jones, Tudor Jones Capital

Elliott Wave is a great trading tool for trading trends. However, its not as confusing as a lot people make it out to be when you consider the primary objective of the tool. Elliott Wave is meant to put the current move of the market in context for you, the trader.

Putting the market in context for you is of great help. For starters, if you know a market that has recently been in a strong trend is correcting, you can look for a resumption of the prior trend to enter at a favorable price. Also, you can look to see if the pattern is starting to break down to see if the prior trend has exhausted itself, and look to either take profits or enter a new trade in the direction of the new trend.

Understand the Basic Pattern

Learn Forex: The Overall 8-Wave Elliott Wave Cycle

The picture above is a mock-up that shows the progression of markets as seen in Elliott Wave. As you can see, the market is often broken up by strong trends and minor moves against the trend. The with-trend moves are known as impulse or motive waves and the counter trend moves are known as correction.

Another key aspect of Elliott Wave is that trends are fractal. Simply put, that means that each impulsive wave can be broken down into 5 smaller waves and each correction can be broken into 3 smaller segments of a counter-trend move. However, its often not overly necessary to label every single aspect of the wave.

How to Understand Corrections vs. Impulses in Markets

Learn Forex: 5-Wave Impulse 3-Wave Corrections unfolding in GBPUSD

Presented by FXCMs Marketscope Charts

As illustrated above, the trend or impulse unfolds in 5-waves whereas corrections unfold often in a 3-wave pattern. Youll often hear Elliott wave fans discussing trading based on 5-s 3-s and that is because they identify the trend and countertrend moves based on the unfolding of a move in 5 3-wave patterns.

Furthermore, in understanding the basic 5-wave impulse or trend, you can be on the lookout for a 3-wave correction or developing correction. The purpose of looking for a correction is that as the trend resumes, you can look for the correction to be losing steam so that you can enter at a good price. What many traders who are unfamiliar with Elliott wave often end up doing is chasing the price or enter on the extension of the trend right before the correction begins. This causes them to get stopped out because they did not understand the context of the market and current trend when they entered the trade.

When looking at the 5-wave pattern and 3-wave correction to get context, you can see how the breaking down of GBPUSD has us looking for a correction to continue. Therefore, Im taking the context as provided by Elliott Wave to get a better feel for GBPUSD. Once this corrective move to the downside completes, then I can look for a buy on a resumption of the overall trend to higher prices.

If youre not trading GBPUSD, you can take a look at the chart youre trading and see if you can identify any 5-wave or 3-wave structures. That will help you grab a context of the current market so that you can look for the maturity of the current trend or ideally the exhaustion of the correction. After youve identified a current market as ready to resume the trend, you can then look to Fibonacci numbers in order to see where the market is likely go to go as according to Elliott Wave.

How to Understand Fibonacci In Relation To Wave Development

“ When R. N. Elliott wrote Natures Law. he explained that the Fibonacci sequence provides the mathematical basis of the Wave Principle”

- Elliott Wave Principle, Frost Prechter pg. 91

Once youve been able to get context for the current trend, you can then look to Fibonacci numbers in order to find price objectives within Elliott Wave. In other words, the reason why Elliott Wave traders often utilize Elliott Wave is because you can have definitive levels as to where the correction may end with Fibonacci Retracements. Furthermore, you can have price objectives by utilizing the Fibonacci Expansion tool.

Learn Forex: Fibonacci Provide Price Objectives within Elliott Wave

Presented by FXCMs Marketscope Charts

One key thing to note when utilizing Fibonacci retracements within Elliott Wave is that there are levels to watch out for but rarely a level that the market must hit. Therefore, you want to focus on price action near levels like the 61.8% on a wave 2 and a 38.2% on wave 4. If you see a lack of conviction past these levels then you can look to a resumption of the overall trend off of these levels.

In terms of price objectives, you can use the Fibonacci expansion tool. The expansion tool takes three points on the chart to project the exhaustion of the next impulse. The most-commonly used targets are the 61.8%, 100% 161.8% expansion. This simply means that this impulse is either 61.8%, 100% or 161.8% of the prior wave and simply shows you the progression and strength of the current trend.

Closing thoughts

Elliott can be a headache if you worry about labeling every wave and every correction. Instead, Id recommend focusing on the big picture. In other words, are we in an impulse or a correction? More importantly, if were in a correction thats about to be exhausted, where can we enter on the resumption of the trend?

Happy Trading!

---Written by Tyler Yell, Trading Instructor

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Forex trend trading indicators

Forex trend trading indicatorsForex trend trading indicators

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Online forex trading bar charts

Online forex trading bar chartsOnline Forex Trading Bar Charts

Forex trading bar charts are the most popular method for Forex trading technical analysis worldwide. They have reached their popularity because they are useful and easy to understand. The activities of the hour/day/week/month is seen as a vertical bar in the chart. Horizontal marks account for Opening and closing prices. Every time you trade in online Forex. it is recommended that you use these bar chart patterns and indicators to help you invest properly.

Recognizing Trend Lines

A trend line is drawn in the bar chart to indicate the price of online Forex trends. An ascending trend line connects between the daily highs of the market. A descending trend line connects the day's low prices. If the downward trend line crosses the most recent prices - a buy signal is generated. If an ascending trend line crosses through the most recent prices, a sell option s generated.

Support and Resistance

If you look at an online Forex trading bar chart that details the change in the currency over time, you will notice that after the graph goes up and down for a few times, there is a horizontal line you can draw at the lowest place the graph arrives to, and also at the highest place the graph goes. This means that after the graph has dropped several times, it never drops more than a specific place - called the support level, and after the graph rises a few times, it stops also at regular places, called resistance levels.

An example of a support level is if the graph goes down to $4, then rises to $6, then goes down again to $4, and rises to $5, goes on to $4, etc. This means the support level for that graph is $4.

support levels are the places on the bar chart where online Forex traders feel the stock will move higher, and buy the currency more than sell it. Resistance levels are when there are more sellers than buyers.

When support levels are penetrated, and the price drops bellow the support levels, then the support level turns into a resistance level that will be the highest place the chart goes to. This is because the traders will sell that currency when it reaches the former support level in order to limit their losses and regain the former price they had.

Reading Online Forex trading Bar Chart Patterns

When you look at a bar chart, you can sometimes recognize patterns that can help you make the next trading decisions by anticipating how the online Forex market is going to behave. After you practice recognizing these patterns you will be able to see them automatically when you see a certain bar chart.

Analyzing Reversal Patterns in Bar Charts

Reversal patterns are recognized in the online Forex trading market with short and close drops and rises in the graph.

A Double Top - Here you see a long rise in the bar chart, then a short drop, another rise and a drop. The prediction says the next drop will be long, and the investor can predict the currency will drop. The shape of the double top looks like the letter "M".

A Double Bottom - The bar chart for this case is a long drop, then a short rise, a short drop and a rise. The final rise is predicted to raise more by the investor. The shape of the chart resembles a "W".

A Head-and-Shoulders Top - This bar chart has one larger top separating the two smaller tops that are similar to the double top. The larger top is called "the head", and the two smaller tops are called "the shoulders".

Head-and-Shoulders Bottom - This bar chart is the same as the previous chart only upside-down.

How to Read Continuation Patterns on Bar Charts

The continuation pattern indicates a certain direction that the online Forex graph follows, that is interrupted by a shot change in direction, and sonly after continues with the previous direction.

The Flag - In this bar chart continuation pattern, the change in direction of the online Forex currency consists of the same difference between the lows and the highs, and a continuing downward or upward slope of the graph.

A Symmetrical Triangle - In this case in the change of direction area the line of the bar chart becomes closer as the previous direction of the chart approaches.

An Ascending Triangle - This graph interruption indicates the unchanging of the high price, while the low price keeps getting closer to the high until the pattern continues.

A Descending triangle - The same as the ascending triangle only with the opposite roles, here the low price is the one that stays the same.

Rectangle - This is a pattern when the high and low prices stay almost the same for some time.

Gaps in the Bar Chart

Gaps occur when the bar chart leaps and leaves a gap between the former price of the online Forex currency and the next price. The breakaway gap continues the former trend in a different place, with a change in direction. An exhaustion gap comes right before a drop indicating the currency's exhaustion. An island reversal gap occurs when the chart suddenly breaks from the previous trend and immediately breaks again to another location. Some Economic Indicators are the causes for such gaps, but sometimes they occur spontaneously by themselves for no apparent reason.

Trudy Bates - Market Expert

Gap trading strategies

Gap trading strategiesGap Trading Strategies

Gaps are areas on trading charts where price has moved rapidly upwards or downwards without leaving any discernible evidence. Consequently, gaps are displayed on candlestick charts by a significantly large distance between two consecutive candles, as illustrated in the following diagram.

Types of Gaps

Breakaway Gaps appear towards the end of trends and signal that a major reversal could be imminent. They are usually followed by a series of new lows on a downside breakout (see below diagram) or a series of new highs on an upside breakout. They are not normally closed. An example is shown in the next diagram.

Exhaustion Gaps are generated by the price exerting one last effort to achieve a lower low or a higher high when a trend starts to peter out. They are closed shortly afterwards. The following diagram shows an example of an exhaustion gap.

Common Gaps can be created at any time and are not identified with any price action. These gaps occur when there is no strong trend. Common gaps are closed quickly as shown in the next diagram.

Trading Gaps

‘The gap is filled’ is an important expression that is applicable when price progresses back to the value it had before the gap was generated. Such events occur relatively frequently resulting from over-enthusiastic trading creating price surges that then need correcting. Successful traders have developed a number of Forex trading strategies to help them profit from gaps, such as the following.

Tracking global news during the weekend can be a profitable venture if you can first identify any major trading discontinuities associated with this activity. If successful, then attempt to deduce the causes for such actions. If Forex then commences the new trading week revealing a gap, you will then be well-positioned to initiate a new position to trade this event. Once price starts to fill a gap, this process rarely ceases because there does not exist any intervening resistances and supports capable of stopping it.

The next gap trading s trategy has been developed to predict price retracements and consists of the following rules. A new position must only be open in the current direction of the prevailing trend. Price must then jump in value forming a gap above resistance or below support before returning to its initial resistance level. Such a process would fill the gap. The following diagram shows such a trading setup.

You must then pause until you can visually detect a candlestick verifying that price is now progressing in the initial gap direction. This technique ensures that the original resistance, which is now the new support, has held. This strategy also presents excellent entry points for new positions possessing optimum reward-to-risk ratios. You should place your stop-loss about 50 pips beneath the new support line as shown in the above diagram.

When to trade gaps

Gap trading is not new and has been used to trade the stock market and commodities for a long time. This strategy is not often utilized by Forex traders. This is because gaps depend basically on the stock markets shutting down for a period of time, such as overnight. However, as Forex does not close except over the weekend, the formation of gaps is much rarer events. In fact, there is only one time when a gap trading strategy is possible, which is when Forex re-opens late Sunday afternoon.

Although this presents minimum opportunities to trade gaps, Forex gap strategies possess high success rates in the region of 85%. So what is the best way to trade Forex gaps? The first important point to understand is that there are only three possible ways that price can change over the weekend.

1. The price can open above Fridays close called gapping up.

2. The price can open below Fridays close called gapping down.

3. The price can open at the exact same price as Friday’s close meaning that no gap has been generated.

The primary rule to trading gaps is fundamental. Whichever direction in which the gap is expanding, you instigate a trade in the opposite direction. You will be amazed just how often this straightforward strategy succeeds and that it could supply you with the basis on which you can successfully construct your Forex career.