Usually, when one trading session closes and another one opens, the price opens at the same level as the previous session's close. But sometimes, either due to some major fundamental event or for some other reason, the opening level of the next session is significantly different compared to the previous session's closing level. Such a phenomenon is called a price gap.
While gaps can occur at any time on any timeframe, especially during major events, most commonly, gaps appear between Friday's close and Monday's open as markets are unable to immediately react to the news that comes out during the weekend. And sometimes, reaction at the Monday's opening can be exaggerated.
Considering how relatively frequent and important the weekly gaps are, it would be interesting to analyze them. In particular, to check if there is any correlation between the size of the gap and the trading range of the week and the day before and after the gap. The correlation between the size of the gap and the next day's and week's trading range would help traders predict market volatility in the near future and to adjust their trading strategies accordingly. For example, it may suggest where to place stop-loss and take-profit levels.
Seven currency pairs were analyzed: EUR/USD, GPB/USD. USD/JPY, AUD/USD, USD/CAD, USD/CHF, NZD/USD. For the purposes of the analysis, an MQL5 script was used to create a .csv file for each currency pair. Each file contains the following values:
The script analyzed 610 or 611 (depending on the available data) weeks starting January 1, 2010. In cases when trading started during Sunday evening, Sunday's data was combined with Monday's session.
Using the script's output, the following average and median values were calculated:
But even more interesting information is provided by the graphs that show correlation (or lack thereof) between the size of the gap and the price range of the day and the week before the gap as well as immediately after.
The average size of the weekly gap is about 80% of Friday's Open-Close range and about 40% of the weekly Open-Close range of the EUR/USD currency pair. The only noticeable correlation (albeit a weak one) is between the gap value and the Open-Close range of the Monday after the gap.
The Forex gap statistics for GBP/USD look similar to those for EUR/USD, with the size of the gap equaling about 40% of the weekly Open-Close range and above 80% of the daily range. No significant correlation between the gap and the trading range of the days and weeks before and after the gap is present.
The average size of the gap is about 40% of the USD/JPY weekly Open-Close range, the same as for the previous currency pairs. But compared with the average daily Open-Close range, it is significantly bigger — more than 150%. No significant correlation between the gap and the trading range of the days and weeks before and after the gap is noticeable.
The average size of the gap is almost 70% of the weekly Open-Close range and more than 100% of the daily Open-Close range for the AUD/USD currency pair. There is no significant correlation between the gap and the trading range of the days and weeks before and after the gap.
The average size of the gap is about 56% of the weekly Open-Close range and more than 70% of the daily Open-Close range for the USD/CAD currency pair. No correlation between the gap value and any of the Open-Close ranges studied was discovered as well.
The average gap represents about 45% of the weekly Open-Close range and about 68% of the weekly range for the USD/CHF currency pair. No correlation here either.
For NZD/USD, the average size of the weekly gap is 43% of the weekly Open-Close and 96% of the weekly range. No significant correlation was found here either.
According to the tables presented above, the average size of the weekly gap is close to the average range between the Open and Close of Friday immediately before the gap. In fact, for USD/JPY and AUD/USD, the average gap exceeds the average range of Friday's trading. The average gap is also about a half of the average range between the Open and Close of the week before the gap.
As for the correlation between the size of the gap and the volatility immediately before and after the gap, it does not seem to exist, unfortunately. The only correlation worthy of at least some attention is the correlation between the gap value and the Open-Close range of the Monday immediately after the gap on EUR/USD. Even then, the correlation is weak. The possible reason why the EUR/USD pair differs from others is the fact that it is the most popular currency pair among Forex traders. Therefore, the large trading volume makes otherwise weak correlation noticeable.
One of the popular strategies involving weekly gaps relies on the idea that the gap between Friday's Close and Monday's Open will be filled during the week. The correlation between the gap and volatility on Monday observed for EUR/USD makes it easier to employ such a strategy. The ability to predict the daily trading range makes it easier to decide should you buy or sell, when to enter a position, when to take profit, and where to put your stop-loss. As the correlation is weak, though, the reliability of such predictions can be low. Therefore, traders should use other technical indicators as well as fundamentals in conjunction with the gap strategy to make their trading decisions.
As for other currency pairs, unfortunately, they do not seem to have a connection between the gap and volatility either before or after it occurs. That makes strategies involving the gap extremely difficult to employ as it is hard to predict how far prices will go before reversing to cover the gap if they do that at all. While it is still possible to employ the Tuesday reversal strategy in those cases, traders should pay more attention to other technical indicators and fundamental factors and less to the gap itself.
If you want to share your opinion, observations, conclusions, or simply to ask a question regarding weekly gaps in Forex trading, feel free to join a discussion on our forum.
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