Types of gaps (part one)

Forex gaps, a technical figure very often used by forex traders, occur from time to time during the trading activity. There are several types of gaps. Continuation gaps and exhaustion gaps are the most famous.

Continuation Gap: it is a figure which forms when a currency pair is already trending and it gaps in the direction of the trend. A “bullish continuation gap” occurs when the gap is observable during an upward trend. A “bearish continuation gap” occurs instead when the gap is observable during a downward trand. The formation of continuation gaps depends on several reasons, but the main reason is the existance of an imbalance in supply and demand. This lack of equilibrium is often due to the decisions taken by the so called “trapped traders”, those who have bet against the market trend and then decide to massively abandon their trades. If the trend is upward and the price continues the strong bullish trending move, then the bears rapidly exit their short bets. Without these traders, the downward pressure on the currecy pair rapidly fades away, causing an excess in demand, resulting in the forex pair to gap up.

Exhaustion Gap: it is a figure which typically forms at the end of a market trend and hints a possible trend reversal. The gap apprears in the direction of the trend and, for this reason, it could be mistaken for a continuation gap. However, exhaustion and continuation gaps depend on different underlying trading strategies. The former usually occurs when the trend starts creating more dynamic price reactions during a short period of time. The volatility surrounding a currency pair increases and big candlesticks are observable, capturing the higher volatility level. The pair generates several impulse waves and suddenly, a gap in the direction of the trend forms. The latter, instead, hints that the number of traders entering the market to bet on the trend direction is reducing, until there are no more traders betting on the trend direction. At that point, the currency pair reverses its trend.

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