Marcs Gap Trading Strategy

Hi, something different for today. A lot of members have asked me to explain more about gap trading. How & why gaps appear. How trading them gives the opportunity to make a lot of pips in a short period of time and how they can work against you. For example if you have a trade open over the week end with say a 20 pip stop. If there is a gap of 120 pips that is NOT in your favour, you have suddenly lost 6 times your intended risk!
For this reason I rarely let trades run over the week end nor open them late on a Friday. The only time I do keep a trade open is as with the recent Gbp/$ short where I had a stop of well over a 100 pips. It was no guarantee but big enough to avoid most gaps.

What Causes Gaps?
There can be a number of reasons, here are the main ones in my opinion

1. Even though the markets close on a Friday evening there is nothing to stop banks and other large financial institutions doing deals over the weekend. If a large trade takes place it can move the market. For example the Euro/$ closes at 1.3000, but on Saturday an interbank deal for a multi million trade takes place at 1.3020 then the markets may open at the new price
2. News. This is the biggest factor. Last weekend the amazing IMG/EU bail out conditions imposed on the Greek Cypriots sent shivers through the markets. If they can suggest this for a member state then every other Eurozone state could  be subject to the same terms and conditions.
3. Natural disasters. Earthquakes, Tsunamis, volcanic eruptions

There are even occasions when gaps occur when the markets are open. I have seen gaps of over 100 pips at NFP announcements. That is why I never trade it.
Why Do Gaps Close?
The standard theory that makes most sense to me is the “Black Swan Theory” which explains that as humans, traders over react, then when they have had time to analyse the situation more rationally, they revert to the mean (see wiki pedias explanation for more details*
How To Profit?
I uses to make a lot of money trading gaps for a multi million $ fund, however a succession of cheating brokers and a change in the market pattern meant I stopped. However the basic principle is that most gaps close. In my experience up to 90% of gaps close at least 80% of the way. Therefore the goal is to get into a trade early enough to catch it.
I use my Sunday analysis to calculate where I think price is likely to bounce. On Sunday I said that I would be interested to long if price pulled back to 1.2900. It did in a heart beat at the market open and literally fell in my lap.
I show in the video how I look to place trades. Where I place my stops. Targets etc. There were many 100′s of pips to be made before New York opened. Weekly target achieved. Job done. Finished for the week!
* Black swan theory
From Wikipedia, the free encyclopedia
A black swan, a member of the species Cygnus atratus, which remained undocumented until the eighteenth century.
The Black Swan Theory or Theory of Black Swan Events is a metaphor that encapsulates the concept that The event is a surprise (to the observer) and has a major impact. After the fact, the event is rationalized by hindsight.The theory was developed by Nassim Nicholas Taleb to explain: The disproportionate role of high-impact, hard to predict, and rare events that are beyond the realm of normal expectations in history, science, finance and technology The non-computability of the probability of the consequential rare events using scientific methods (owing to the very nature of small probabilities) The psychological biases that make people individually and collectively blind to uncertainty and unaware of the massive role of the rare event in historical affairs
Unlike the earlier philosophical “black swan problem”, the “Black Swan Theory” refers only to unexpected events of large magnitude and consequence and their dominant role in history. Such events, considered extreme outliers, collectively play vastly larger roles than regular occurrences.