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Playing the gap in cryptocurrency trading

In Trading

If you have spent any time looking at crypto charts, you’ve likely seen a gap.

The gap is the point on a chart where the open price is significantly different to the previous close, to the point where there is a noticeable gap between the open and close of the different candles.

Gaps are also known as “windows” in Japanese candle analysis.

They’re more common in traditional markets that aren’t 24/7. But while the crypto markets don’t close, gaps can still form due to traders moving their bids and asks based on market sentiment.

Much like other market trends, a gap on a longer time frame is usually more notable than one on a shorter time frame. Gaps are rare in crypto markets, but when they do form, they can tell you a lot.

A common rule to keep in mind is that gaps are often “filled” - so the price is expected to move back to fill the gap that formed.

It’s also possible for the gap to act as support or resistance.

Notice how in the picture below, the price moves down to fill the gap, but for the next four periods the price fails to close beneath the support level provided by the gap.

There are four types of gaps we are going to look at:

  • Common
  • Breakaway
  • Runaway
  • Exhaustion

Common gaps

The name is a dead giveaway - a common gap is indeed common in comparison to the other forms of gaps.

These gaps appear most frequently and they don’t fit into any of the other gap categories we are going to talk about. Generally, a common gap is not related to any major event in the price action.

The distance of a common gap should be small. Based on its size and positioning in the price action, there is little analysis that you can base off this gap.

When a trader spots a common gap they expect it to be filled, usually faster than any other type of gap.

However, remember that gaps are not always filled.

Breakaway gaps

A breakaway gap signifies the break of a trend, and the beginning of a new one.

You can spot a breakaway gap by seeing a gap occur after a strong trend has played out. The gap must be supported by a spike in volume. The higher volume alongside the gap shows decisive movement.

A breakaway gap would be most common after a big announcement or piece of news that massively shifts sentiment.

Breakaway gaps often don’t fill for a long time, or at all.

You can use a breakaway gap as a signal for additional price movement in the direction of the gap.

Watch out for the price coming back and testing the gap as a support or resistance level. If the gap holds as support or resistance, this further solidifies the new trend.

Look at the gap below on the ETH/USD chart.

Once we zoom out, and also look at the spike in volume, it makes sense that this led to an uptrend.

Runaway or continuation gap

After a breakaway gap, you may spot more gaps in the price chart that can be classified as runaway gaps, also known as continuation gaps.

Runaway gaps are caused by new traders taking interest and trading with the trend. A runaway gap signifies that the trend is still strong.

Higher volume is somewhat expected with a runaway gap, but is not as important as it is for a breakaway gap.

Exhaustion gaps

While a breakaway gap breaks away from an existing trend, the exhaustion gap occurs in an existing trend, and suggests that the trend is nearing exhaustion.

If the price of an asset has been increasing for some time, and then a significant gap forms while still following the trend, this suggests the positive trend is almost over.

Once again, watch the volume during the gap. You will either see low trading volume alongside the exhaustion gap, or extremely high volume.

Low trading volume here suggests that the trend is reaching reversal, as there are few traders contributing to the gap.

Extremely high volume shows that there are so many traders chasing the trend that it will become unsustainable, hinting at reversal.

Keep in mind that an exhaustion gap does not signify the end of a trend, just that it is near.

It can be tricky to tell the difference between an exhaustion gap and a runaway gap, even with the volume hints.

Usually traders identify an exhaustion gap once the trend has broken. At this point, prices may not reach these extreme levels for quite some time.

See in the picture below the gap between the green and the red candle, which then led on to break the uptrend.

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This content is not financial advice and should not form the basis of any financial investment decisions nor be seen as a recommendation to buy or sell any good or product. Trading cryptocurrency is complex and comes with a high risk of losing money, particularly if you trade on leverage. You should carefully consider whether trading cryptocurrencies is right for you and take the time to learn how trading works and decide how much money you are prepared to lose.

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Liquid

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