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Do you want to know how a gap in the stock exchange is created? – Then this page is the right place for you. Many traders are always amazed by why a gap is created and why it is created. As a professional trader, it is important to understand the background behind the gap. This is part of general stock market knowledge. According to our research, there is no website in the German-speaking world that explains exactly why a gap is created. We are now taking over this task as the team of day-traders.org.
What is a gap?
A gap is a price gap that can occur between the closing and opening of the exchange. A gap can also occur when there is insufficient liquidity in the market. The picture above shows an example of a gap. If you are a Forex, CFD, Stock, ETF, or Future Trader, you have probably noticed these price gaps before. These price gaps can be very dangerous because if your position is affected, you will get an execution at the best possible price. Losses or gains can increase due to gaps.
How does a gap occur overnight?
The exchange is closed overnight (depending on the market) and no trading takes place. Why and how does a gap occur now? – When the stock exchange opens, it has to set a new price again. This is done by limit orders in the market. These orders sit at different prices and wait to be executed by market orders (direct buying and selling). The exchange is closed and therefore no trading takes place. The exchange must be based on the number of limit orders in the market. Usually, this happens a few minutes before the opening of the exchange.
- Limit orders determine the new opening price
- The exchange determines the new price on the basis of the limit orders shortly before opening
How does a gap arise in active trading?
A gap (price gap) can also occur in active trading due to insufficient liquidity. This can happen when volatility is high, as many market participants stay out of such situations. Market News is a good example of this. Before these events, many limit orders are deleted from the market and the order book is accordingly “thin”. In certain markets, it can happen that limit orders are no longer available at several prices. The market now makes a “gap” and trades at the next fair price.
- Gaps in active trading occur due to insufficient liquidity
- There are no buyers or sales at certain prices
- The stock exchange is now looking for a fair price for trading
The risk of a gap overnight
Certain assets are only traded a few hours a day. Other markets are open 24 hours a day. There the probability of a gap is very low. Before you start a trade you should check the trading hours of the market to avoid a nasty surprise. Special risk also applies to leveraged positions.
Day traders avoid the risk of a gap overnight by closing out all positions before the market closes. Longer-term traders must live with the risk of a gap. From our experience, the risk can be very high. Often there have been cases where the market has a gap of over 10%. You have to take this risk into account when trading, but it also depends on the market characteristics.
The risk of losing money can be very high. Especially if you build up large positions shortly before the market closes. The risk here is that there is a large gap and the stop loss is activated. However, the stop loss can only be executed at the newly calculated prices after the gap. It is therefore possible to lose more money than your Stop Loss limits. However, thanks to regulation, negative account balances are not possible when trading Forex and CFDs in Europe.
Gap Trading Strategy – Is a gap always closed?
Are there gap trading strategies? – Many traders always rely on “Gapclose”. This means that after a gap is formed, the gap is closed again by the market. Traders are stopped out by the gap and must close their positions. Therefore, a trend reversal and a gap close often occurs. Our research and experience have also shown that a gap closure is highly likely to occur and be completed. Then you can find good entries for a position on the way to a gap close.
Summary: A Gap is part of the everyday life of the stock market
A gap is part of stock market trading. Depending on the market, gaps can occur more often. In Forex trading, for example, there are few gaps, because trading runs 24 hours a week. A gap must arise when the stock exchange is looking for a new price and there is not enough liquidity. This causes price jumps before the opening of the exchange or during active trading. These price gaps can be dangerous. Therefore you should know the trading hours and information about your traded market exactly.
Summary about gaps:
- Gaps occur between close of trading and opening of the exchange
- Gaps occur when there is too little liquidity in the market
- The exchange searches for a new suitable price based on the limit orders
- Gaps can become risky for your trading positions
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