Closing gaps are a great way to generate accurate predictions that can be traded with a high winning percentage and a high payout. But before we let you in on which gaps are likely to close, we have to be sure we agree on what a gap actually is.
What is a gap?
A gap is jump in the market form one price level to the next between periods. One period opens significantly higher or lower than the close of the preceding period. The open space between the last period’s close and the current period’s open is called a gap. Gaps indicate a sudden surge of demand or supply that has made the market jump up or down.
Gaps are significant events. Any trader should notice them and adjust his trading accordingly. The trouble with gaps is that there are three different gap types, all of which generate very different indication. Breakaway gaps indicate the creation of a new trend. Runaway gaps indicate that the current trend is picking up momentum. Exhaustion gaps indicate that the current trend is likely over.
Which gaps are likely to close?
From the three gap types, only one is likely to close. Breakaway gaps and runaway gaps indicate market movements in the direction of the gap. Therefore, the market most likely will not reach the price level of the gap again anytime soon. Instead, the market will move away from the gap.
The exhaustion gap, on the other hand, is very likely to close.
Exhaustion gaps occur during periods of low trading volume, when a few traders keep pushing the market in the direction of the preceding movement, but most traders are no longer willing to invest. Sooner or later, these few traders will not be able to maintain the current price level by themselves. Instead, the majority of traders will pull the market down back.
After the gap, the market might be able to keep the new price level for a few periods, but will eventually turn around and start moving in the opposite direction of the gap.
In case of an exhaustion gap, it will not take long for the gap to close. Usually, the market closes the gap within a few periods: As soon as other traders realize that the trend is in trouble, they start taking their profits and reinforce the prediction made by the exhaustion gap.
To trade closing gaps, you have to search for exhaustion gaps.
How to trade closing gaps
Closing gaps can generate very accurate predictions. When you recognize an exhaustion gap, you can predict the minimum range the movement will have: The movement will at least close the gap. That knowledge helps you to invest in a touch option. Touch options generate significantly higher payouts than high / low options, but require you to estimate the range of a movement.
With closing gaps, estimating the range of a movement is far easier than in a movement that’s out in the open. Therefore, closing gaps provide an excellent opportunity to invest in a touch option. Of course, you can trade gaps with high / low options, too. In that case make sure to choose a short to medium expiration time in relation to the time frame of your chart.
Try to avoid using a too short expiration time that does not allow the movement enough time to develop.
To trade closing gaps, you should never use boundary options. Gaps allow for a strong prediction about the future market direction. Therefore, covering both sides with boundary options is a small advantage compared to the higher payout generated by touch options.