Trading Exhaustion Gaps

By trading exhaustion gaps you can attain both a high winning percentage and a high payout rate. This makes this trading technique potentially very attractive.

Introducing the exhaustion gap

In the financial markets, a gap occurs when the price of an asset jumps markedly from one time period to the next. In other words, when there is a large difference between the closing price of one period and the opening price of the next period. Gaps are important occurrences that are caused by significant events.

Outcomes that can be caused by gaps include the creation of a new trend or the acceleration of an ongoing trend. Gaps that lead to such results are called breakaway gaps and runaway gaps. Both of them act as indications that that a trend is about to start in the direction of the gap. A lot of traders, predominantly trend followers, like to trade this sort of gap.

A gap type exists, though, that indicates the opposite of what these gaps do. That is the exhaustion gap. The occurrence of an exhaustion gap suggests that an ongoing trend is weakening and that a reversal is imminent. Recognizing an exhaustion gap, can save traders from unfortunate investment mistakes. It can also help him find excellent trading opportunities.

The exhaustion gap is caused when some traders push the market upwards at the same time as the majority of investors are unwilling to enter the market. As a consequence, leading up towards an exhaustion gap trading volume will be low. An exhaustion gap appears when the ongoing market movement is probably over. The market will soon move in a different direction.

In many cases, an exhaustion gap will be followed by a second gap moving in the opposite direction. The candlestick formation made by this development is referred to as “the island reversal.” This is a very strong sign pointing towards a turnaround.

How do I trade exhaustion gaps?

There are essentially two main ways in which you can trade exhaustion gaps. Which one is best for you, depends on your strategy and overall circumstances.

1. Trade the exhaustion gap when it appears

The market will turn around soon after an exhaustion gap occurs. For this reason, making a rapid investment will allow you to benefit from this knowledge. You do this by investing in a touch option in the opposite direction of the gap. Investing in a touch option is preferable to using a High/Low option because it offers a higher payout.

Having said that, this strategy requires you to invest immediately after the gap occurs. Thusly, you won’t be able to wait for confirmation from the market. You simply don’t have time for an island reversal candlestick to be formed. This means that this strategy incurs a reasonably high risk. Seeing as a touch option pays out as much as 5 times more than High/Low options, this will be evened out over time.

2. Invest once the market has confirmed the exhaustion gap

If you do not like the relatively high risk of immediate trading, you can wait for the market to confirm the exhaustion gap before you strike. This will happen within a few periods. Either the market will turn around or a gap in the reverse direction of the exhaustion gap will occur. The result will be an island reversal. If this candlestick formation appears, you have a very strong indication that the market really is turning.

Waiting like this will probably make you lose out on part of the movement. For this reason a touch option would be a very high risk choice. You will probably attain greater profits by investing in a High/Low option.

How do I identify exhaustion gaps?

Low trading volume is a prerequisite for the appearance of exhaustion gaps. When you are looking to trade an exhaustion gap, the first thing you need to find is therefore a period with low volume.

The end of the trading day might be a good place to start. The big traders might have completed their trades for the day already. Also, many investors will choose to cash in profits they’ve made at this stage in order to protect them from unpredictable events that can occur overnight.

This adds up to a situation where fewer traders are actively influencing the market movements. What’s more, the traders who remain will probably be investing against the trend. This makes for perfect conditions for an exhaustion gap to occur. If you want to trade an exhaustion gap, you ought to find periods such as these and keep your eyes open for opportunities.

Conversely, gaps that occur during earlier parts of the trading day when the volume is higher, are more likely to be runaway gaps or breakaway gaps. These gaps need to be traded according to very different strategies than exhaustion gaps.




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