The Sunday gap fill myth

[Fairman]

The Sunday gap fill myth

Everybody has heard it: gaps always fill. A bit of searching shows it is rather less certain than the folklore suggests.

On major currency pairs, weekend gaps are usually small, a few pips at most. Plenty of them close within the first hours, mostly because the first quotes of the week are thin and wide, and the spread has more to do with the gap than any real price change.

On bigger gaps, those following a major weekend event, the move often continues instead of filling. The gap is not a hole in the chart but a repricing, and the market has no obligation to return to where it was.

Scalpers who trade the fill often get a handful of small wins and one large loss when a real gap fails to close. The maths seldom works out as neatly as the story suggests.

A better question is whether a gap came from a change in information or just a quirk of thin quotes. The first deserves respect. The second is mostly noise.

There is a version of the gap fill idea that does hold up: small gaps under about 10 pips in liquid pairs fill within a day more often than not. The reason is partly mechanical and partly that these gaps are mostly noise. The mistake is stretching that observation to gaps of 50 pips or more, where the cause is almost always real information.

A decent filter is looking at what happened over the weekend. If nothing in the news explains the gap, it probably reflects thin quoting and tends to fade. If the weekend contained an election, a central bank surprise, or a geopolitical event, the gap deserves respect, and fading it is a bet against new information.

Backtesting this on ten years of data shows a pattern most people do not expect: the average gap fill is quick for small gaps and slow for large ones, and the large gaps contain nearly all of the pain.

Has trading a gap fill ever gone badly wrong?