In the realm of Forex trading, market gaps are something which every trader will have to deal with at some stage. It doesn’t matter if you are trading in currency pairs or using a broader market strategy, knowing market gaps and their associated risks is important if you want to succeed in the long run. For proprietary (prop) firm traders, gaps in the market can result in absolute nightmares regarding profitability as well as the risk management strategy. These tend to be very unpredictable and volatile in nature, often determining whether a trader is in profit or suffers a catastrophic loss.
To start off, we need to explain what a market gap is. A gap is defined as when there is a movement in prices without any accompanying trading taking place in the range being assessed. This means the price is open at a point that is far away from where it closed in the previous trading session. These gaps can appear when there is an important economic announcement, some form of nagging news comes out, or when the market is closed over the weekend. Gaps in the fierce and fast moving world of Forex are often considered to be hazardous as they can set off large price movements which give the trader almost no time to adjust their position.
For firm prop traders, these gaps may prove especially risky for numerous reasons. A prop firm is a company that allows traders to use the firm’s capital to trade, and in return, takes a share of the profits. A prop firm has highly detailed risk management policies. The traders are usually given some amount of leverage to boost the profits, but that same leverage can turn into a curse during a market gap. Now, let’s delve into some of the major risks that market gaps can create for prop firm traders.
The Importance of Leverage in Gaps
One of the more notable reasons market gaps are extremely risky in relation to prop firm traders is the concern of leverage in Forex trading. Traders who participate in Forex utilize leverage which allows them to hold bigger positions than what their finances would allow. This is made possible through leverage which enables a trader to actually possess a $100,000 position while only having $1,000, at 100:1 leverage. Even though leverage enhances profits, it remarkably strengthens losses even more in harsh conditions.
When the gap in the market occurs, the price of a currency pair can jump in one direction without any liquidity in between. This means, for example, that a trader with a predefined stop loss or an entry limit may suffer considerable losses because they are likely no longer protected at the stop-loss or entry price. Such a situation is likely when an unexpected economic report is released. For example, a trader who is holding a position in a currency pair like EUR/USD may lose out on profit because the price might suddenly open greatly below the already set stop-loss level. In such cases, the trader will lose more money than he intended, irrespective of the stop-loss order placed. Due to the gap and the high amount of leverage used, the order would most likely not be filled at the price that most people think, causing the losses to be even greater.
Capital could be almost completely drained from an individual in a worst-case scenario by the gap. This subsequently would cause the withdrawal to be made as a loss, or even worse, lead to receiving margin calls from the prop firm. Having your dependency on the position heavily constructed can trap the trader in a scenario where profit can seamlessly turn into an alarming loss, and therefore act like a ticking time bomb.
Accommodating Gaps In Markets
One of the more important disadvantages lies with the lack of liquidity in Forex during a market gap. Forex markets have a reputation for being quite liquid. However, during particular news updates or economic analysis reports, liquidity can dwindle, causing Forex brokers to not be able to fill orders at set prices. As with any financial market, there are periods of stagnation where not much activity is taking place termed: gaps. In gaps, the price can change, during the gap, to a level far above or below where it was, with no trading activity in the range. This situation can create scenarios in which traders cannot place orders at the close or take profits at reasonable priced levels.
Traders with prop firms, as they bear the brunt of the losses in this situation, face lack of liquidity in these gaps, perilous. Not allowing escape from trades as they reach their loss limits will give rise to much greater losses than intended. Caught in a gap, unable to maneuver in and out of trades, traders, especially ones that rely on high volumes of easily filled orders, cut far too deep into their budget. In this set of conditions, complete lack of liquidity with low activity levels becomes the prime culprit, lighting the fuse on the already volatile situation created by gaps in the market.
Instability and Uncertain
Market volatility generally occurs due to some jubilation or catastrophic event such as the surprise announcement from central banks, geopolitical upsurge, or new economic data publication. Truth be told, as much as volatility in the market can help an investor in making a profit, it can also act as a double edged sword in this ever-changing market, especially for day traders who do not have sufficient time to make adjustments to their plans.
For proprietary traders, the active shifts in the market can lead to significant changes in their accounts. Given the nature of market gaps, it becomes exceptionally troublesome to forecast how the market will behave next. Traders who happen to misplace their bets incur staggering expenditures in the blink of an eye. Many times, the fury of change is too much and too quick for them to handle, thankfully accompanied by other options.
In Forex trading, this sort of volatility is particularly hazardous to prop firm traders who are struggling to meet deadlines for consistent returns. A single unexpected gap adds a lot of risk on volatility and it can completely destroy a trader’s strategy and reputation within the firm. Besides, a large amount of exposure can increase risk drastically if traders are heavily involved with multi-currency pairs that are volatile due to gaps.
Enhanced Risk of Margin Calls
Market gaps pose great challenges for prop traders, and margin calls are one of the issues. Most prop firms are known to have stringent margin policies, and should a trader’s account balance drop below the applicable margin level, they must put in more capital or else their account will be closed. Should a trader’s positions suffer heavily due the market gap, odds are, they will end up getting a margin call.
When gaps cause a significant loss, prop firm traders may find themselves with insufficient capital to bridge the gap between their margin and the equity left in their account. If the market is moving against them quickly, it is often too late to do anything about mitigating the problem before the margin call is executed. This in turn means that the trader will be left with no option but to have their positions forcefully closed, which leaves them with zero balance in the account and strained financially and relationally with the prop firm.
Risk of Over Leveraged
Market gaps can also put traders in the more severe conditions of over-leveraging. Traders who gap are highly emotional and do irrational things which makes them attempt to recover their losses by using far greater than normal levels. This irrational behavior, without proper risk management, almost always guarantees larger losses because the gaps caused by forced volatility are disregarded completely.
This inclination is particularly perilous for prop firm traders due to the availability of the firm’s capital, as it may induce a comforting sense of security. Nevertheless, the very access to that capital may, in the event of a market gap, result in reckless trading choices that exacerbate the problem. In such a case, overleveraging may significantly accelerate losses propelling traders who do not identify the risk level, into a complete collapse.
Conclusion
In closing, market gaps pose considerable dangers to prop firm traders as it pertains to Forex trading. The gaps themselves, along with the leverage, lack of liquidity, volatility, possibility of margin calls, and the urge to overleveraged, combined present a danger of gap trading. Although gaps create chances for trading, they also highlight the unpredictability of the market, especially during the trading of very liquid currency pairs. It is vital for prop firm traders to comprehensively understand and navigate these risks by formulating effective risk management plans to counterbalance the prospects of losses brought about by gaps. Preparedness and vigilance are crucial in overcoming the challenges of gaps, enabling traders to achieve a consistent trading approach.
