Gap Risk

The forex market is often characterized as the most liquid financial market of all. Liquidity refers to the number of active traders and the overall volume of trading present in a particular market at at any given time. Liquidity is typically experienced in terms of the volatility of price movements.

Gap risk indicates the potential for prices to jump from one price level to another with no tradeable prices in between. Sources of price gaps include key technical levels, economic data reports, central bank rate decisions and other news events. Unexpected news can also initiate price gaps. But usually they can be foreseen by tracking data and event calendars.

A common gap risk is from twenty to eight pips after a news event breaks. Gaps are caused by the interbank market reducing its bids and offers within minutes or immediately before or after the news is announced. Once the news hits, interbank traders adapts their prices to mirror the news which causes the price gap either to go higher or lower.

It may take up to thirty seconds or more before normal pricing returns. Not a long time in some markets but in the forex market, it can cause quite a stir. Traders are subject to gap risk if they are holding an open position at the time major news is reported.

Another form of gap risk occurs from events taking place over weekends. This is somewhat predictable because it often transpires around scheduled events such as a G20 meeting or a Chinese data release. The result: a significant gap between Friday’s closing and Sunday/Monday opening price.

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