Gaps in the support and resistance levels formation. Examples
This article complements «Horizontal levels in trading» course.
Not all markets move smoothly, some of them often cause price gaps. In this article we will discuss how to interpret gaps in the levels breakouts and how market closing within the nearest support or resistance level affects the breakout existence.
GBPUSD. Gap formation. Example 1
Let’s analyze this by the example of the Daily timeframe of the GBPUSD currency pair. By January 16, 2017, the support level has been formed, the lower border of which is at the price of 1.2037, the upper one is 1.2156. This is a classic level, formed by two bear and two bull candles. This is a level of the first type. Let’s determine its borders and paint them out (Figure 1).
During the next day the market opened far enough from the closing price of the previous one, below the support level. The price rose by about 50 points. The closing price of this candle was within the support level, there was no fact of a breakout.
It is important to note that while breakout trading with pending stop orders the probability of their triggering in such situations is high. The market can touch the pending order with a shadow and then close inside the level. As a result, there is no level breakout, whereas the position is already open.
If you trade a classic breakout and wait for the candle to close, then there will be no such signal in this example. The price has been just for some time below the support level and is closed within it (Figure 2).
Then a new signal begins to carry out, a bull candle is closed which has updated the resistance level. Let’s see what’s happened earlier.
The support level is formed. We will underline this price area. The lower border is 1.2196, the upper one is 1.2234. This is a classic level of the first type. It is formed on the grounds of two bear and two bull candles. After the bear candle closing, the next one is opened with a small gap and was closed below the support level (Figure 3).
These examples indicate that despite the appearance of gaps it is important to understand where is the candle price closing relative to the existing levels. Only after that we can talk about the fact of the level breakout or about the price that could not break through this or that level.
GBPUSD. Gap formation. Example 2
Another prime example is November the 7th, 2016. The market has been rising for a long time, then the candle is opened below the closing price of the previous day. After that the market is falling and the next bear candle is closed.
If this had happened above, then the resistance level would not have been formed. In this case there is a serious price shift down as the bear candle has been closed much lower than the open price of the previous one. In such situations this candle can be considered as overlapping one. So a new resistance level is formed here. The upper border is 1.2557, the lower border is 1.2517. (Figure 4)
Let’s summarize. You should always focus on the price closing and you will never have doubts concerning what is going on in the market and whether a breakout or a new level has been formed or not.
Traders often make the process of plotting horizontal support and resistance levels much more difficult than it needs to be. Some of them tend to complicate this task by plotting unnecessary levels confusing them in determining further price movements in directed trading. After getting the Levels indicator you won’t have any difficulty in this due to the simplicity of its use. It can help not only identify price zones where the market movement can slow down or price reversal is likely to occur but also find entry signals that appear during a deep market correction or calculate stop-loss and take-profit.
Good luck in trading!