When looking for low risk opportunities, one situation that’s not as common in the futures market as it is with stocks is the formation of gaps. The reason stocks tend to gap more frequently is simply because they spend more time closed than trading with lots of activity. This exposes stocks to all types of gap risk such as market risk, or news related to the individual company. Alternatively, because futures trade continuously twenty four hours a day, roughly five and a half days a week, most gaps are created on Sunday at the open, and even then gaps are rare. It’s not like there’s a gap open every Sunday throughout the futures markets. Even more unusual are gaps formed in the middle of the week during earnings seasons. More on these later.
Because gaps are so uncommon, when they do occur they can produce high probability opportunities . Since our main focus is finding price levels were the forces of supply and demand are most out of balance what better example of that than a gap opening. Let’s think about how a gap occurs. In the chart below, note that the closing price of the December 2014 Australian Dollar futures contract on Friday was .8769, and on the following chart the opening price for Sunday was .8734. This left a price gap of 34 ticks.
First, the simple fact is that when all the orders started to come in Sunday afternoon there were an abundance of sell orders hitting the tape, and since those orders have to be matched with buy orders the nearest buyer came 34 ticks lower at .8734. The reason that compelled so many to sell is irrelevant, and yes , you can find out why but that won’t assist in finding a high quality trade. What’s most important here is that the creation of this gap represents the best picture of an imbalance of supply and demand. In this case, it is a supply imbalance. This suggests that there might be additional sell orders remaining to be filled.
As I mentioned earlier, the rarest of gaps are formed in the middle of the week. These typically form during reporting season for stocks. They occur because the stock index futures close for a very short period (15 minutes ) every week day between 4:15 and 4:30 EST. This is when the day session ends and the overnight session begins. One such gap occurred on October 28. On that day two major components of the Nasdaq 100 index (Twitter and Facebook) reported disappointing earnings. Commonly, companies that report their earnings after the closing bell usually release their results a few minutes after the close, producing a spike in price in the Futures market. In this instance however, both companies earnings hit the tape during the small window when the stock index futures were closed. The after-hours selling in these two stocks is what created this gap in the Nasdaq futures.
As we can see on the charts, this presented a low risk high probability shorting opportunity.
To trade gaps properly, the odds enhancers, such as structure of the level, first retracement and so on, have to score high in order to enable a high quality opportunity.
All told, gaps represent a big order imbalance, and as such we must always be on high alert when they happen. There is one caveat though, not every gap is tradable. This has to do with where the gap was formed in terms of the location of the move. In other words, was the gap created in the late stages of a move, or near a reversal of the trend? This is key information before taking the trade. This a good starting point in understanding gaps, and I hope this was helpful.
Until next time, good trading.
This content is intended to provide educational information only. This information should not be construed as individual or customized legal, tax, financial or investment services. As each individual's situation is unique, a qualified professional should be consulted before making legal, tax, financial and investment decisions. The educational information provided in this article does not comprise any course or a part of any course that may be used as an educational credit for any certification purpose and will not prepare any User to be accredited for any licenses in any industry and will not prepare any User to get a job. Reproduced by permission from OTAcademy.com click here for Terms of Use: https://www.otacademy.com/about/terms
Editors’ Picks
AUD/USD remained bid above 0.6500
AUD/USD extended further its bullish performance, advancing for the fourth session in a row on Thursday, although a sustainable breakout of the key 200-day SMA at 0.6526 still remain elusive.
EUR/USD faces a minor resistance near at 1.0750
EUR/USD quickly left behind Wednesday’s small downtick and resumed its uptrend north of 1.0700 the figure, always on the back of the persistent sell-off in the US Dollar ahead of key PCE data on Friday.
Gold holds around $2,330 after dismal US data
Gold fell below $2,320 in the early American session as US yields shot higher after the data showed a significant increase in the US GDP price deflator in Q1. With safe-haven flows dominating the markets, however, XAU/USD reversed its direction and rose above $2,340.
Bitcoin price continues to get rejected from $65K resistance as SEC delays decision on spot BTC ETF options
Bitcoin (BTC) price has markets in disarray, provoking a broader market crash as it slumped to the $62,000 range on Thursday. Meanwhile, reverberations from spot BTC exchange-traded funds (ETFs) continue to influence the market.
US economy: slower growth with stronger inflation
The dollar strengthened, and stocks fell after statistical data from the US. The focus was on the preliminary estimate of GDP for the first quarter. Annualised quarterly growth came in at just 1.6%, down from the 2.5% and 3.4% previously forecast.
RECOMMENDED LESSONS
Making money in forex is easy if you know how the bankers trade!
Discover how to make money in forex is easy if you know how the bankers trade!
5 Forex News Events You Need To Know
In the fast moving world of currency markets, it is extremely important for new traders to know the list of important forex news...
Top 10 Chart Patterns Every Trader Should Know
Chart patterns are one of the most effective trading tools for a trader. They are pure price-action, and form on the basis of underlying buying and...
7 Ways to Avoid Forex Scams
The forex industry is recently seeing more and more scams. Here are 7 ways to avoid losing your money in such scams: Forex scams are becoming frequent. Michael Greenberg reports on luxurious expenses, including a submarine bought from the money taken from forex traders. Here’s another report of a forex fraud. So, how can we avoid falling in such forex scams?
What Are the 10 Fatal Mistakes Traders Make
Trading is exciting. Trading is hard. Trading is extremely hard. Some say that it takes more than 10,000 hours to master. Others believe that trading is the way to quick riches. They might be both wrong. What is important to know that no matter how experienced you are, mistakes will be part of the trading process.