Trading on the eToro platform has evolved, offering an intuitive interface and ample educational resources. However, traders must be aware of market nuances that can impact their investments, like price gaps. Let’s dive into price gaps, their types, and how to navigate them effectively.
💡 Key Takeaways
|→Price gaps occur when an asset’s price differs from the previous trading day’s closing price.|
|→Gap types include common, breakaway, runaway, and exhaustion gaps.|
|→Price gaps can lead to unexpected losses or gains in your investments.|
|→Implement risk management strategies to minimize the impact of price gaps.|
❓ What is Price Gapping?
Table of content
- ❓ What is Price Gapping?
- Price gapping on your eToro account
- 🌟 Types of Price Gaps
- 📈 Pros and Cons of Price Gaps
- 🛡️ Managing Price Gaps
- 🔚 Conclusion
- eToro Trading Strategies: • Learn more about eToro Trading Strategies📝
- Market Conditions:
- Risk Management:
- GENERAL RISK WARNING
- Author & Expert Trader - Financial Analyst :
A price gap occurs when an asset’s price differs (above or below) from the closing price of the previous trading day. This discontinuity in a stock’s price chart can result from various factors, including news events, earnings reports, or changing market sentiments. Gaps can be partial, with the opening price still within the previous day’s range, or full, where the opening price is completely outside the previous day’s range.
Price gapping on your eToro account
But let’s consider how this could happen in practice to make things more simple. Suppose you want to buy a few stocks of Apple i.e. go long in this stock, for a total monetary amount of $100. Although the price of Apple stocks might be much higher, this trade is possible because eToro allows you to trade with only fractions of shares. You always have the option to use leverage to amplify the size of your trade and so you choose the maximum level of leverage allowed for this asset type, which is x5. Now to protect yourself in case things don’t go as hoped for and the asset decreases in price, we set a certain level of stop-loss. This automatic trigger will close down your trade when it reaches a certain level of loss. Given your degree of risk aversion and the limited available capital, the maximum loss you can take on in this trade is $20. So if the value of this position will ever goes down below $80, it will be automatically closed down by the platform and the remaining $80 will be returned to your available balance. The trade placed will then look like the image below.
Now, you are hoping to make some money on this stock (or part of it) over time, so you leave it overnight and come to check up on it the next day. Suddenly, your portfolio is empty and the position is not there. Why did this happen? Perhaps the stop-loss was triggered and now the remaining $80 is back in your account? Instead, you might discover that you haven’t lost $20 but instead, as much as $40 or $60 when your trade was closed! Why did that happen? Is eToro a scam and stop-losses don’t work? The answer is no of course and instead, you found yourself in this situation because of a market phenomenon called price gapping.
The first thing to understand about the entire process is that markets are not open all the time. Apple is traded on NASDAQ, a USA-based exchange, which closes and opens at certain hours only, like any other business. When you trade Apple stocks (or stocks of any company registered on this exchange) you can actually only do so when this exchange is open, during its working hours. But that is not the only time trading can occur, as you might have placed your trade during hours it was closed. Before and after markets like NASDAQ are open (or in technical terms, pre-market and after-market hours) there are still traders who can trade Apple stocks and consequently move its prices. Why can’t anyone do so? Well, it is only a very limited number of brokers that allow their investors to trade on these outside market hours and eToro provides trading opportunities within market hours only. In fact, trading outside market hours can be very risky and volatile and these trades are completed on electronic communication networks (ECN) outside the usual stock exchanges. Such orders tend to face higher liquidity risks, wider spreads, and rapidly changing prices.
After you completed your trade while the market was open, some terrible news comes out on Apple in the evening, for example, a fraud scandal or an unpromising earnings report is released and investors massively lose their trust in the company. After the market investors that no longer believe in the company start selling its shares in large volumes. Consequently, because of the increased supply of these stocks on the market, the price goes down, by the basic economic law of supply and demand. What you see for your trade on the platform though is the old latest price the asset was traded at when NASDAQ closed the day before. So the price shall remain the same and it will only be updated on the eToro feed when the markets open the following day. So despite the markets being closed at the time the price is actually decreasing. Despite the after-market trading has caused several up and down changes in price after NASDAQ closed at 16.00, as shown below.
The price on eToro shows the closing price and does not reflect these outside market hours changes yet and stays at yesterday’s closing level.
What we can see is that actually the real price at the moment right now is different from its yesterday closing price and although the price is changing in real time the price that you see on the platform is the same. The next day when the markets open the price that Apple will be trading at on eToro is going to change and it will finally reflect the actual price that accounted for the effects of trading that happened after the market closed yesterday and before it re-opened today. Many times these changes are relatively minor (as in the example above) and could even be profitable for you.
But lets get back to our unfortunate $100 trade. Now the stop-loss level you have set for your trade is linked directly to the real-time price from NASDAQ, and although the price might have gone down well below the $20 you have set, eToro will not realize that until the markets re-open and the lower price of this stock will be updated. Only then the stop-loss comand shall trigger even though you might have lost much more than the original level you set for this position.
Of course if the price drops down during the open times of the stock exchange when the price on eToro is being constantly updated according to it, the stop-loss will be triggered as soon as those $20 are lost as you have set up. When this situation happens outside market hours like in our example, eToro will close down your trade at the next best possible price level as soon as it sees the price went down way below your stop-loss level, for example to $70 or $60. That is much more than you originally planned to lose.
We can also visualize this situation on charts. Each candlestick bar on a price chart represents a one-day time frame of trading. If the bar is red, it means the opening price was the one at the top of the bar and it closed at the bottom of it, meaning the asset decreased in value. For the green bars the opposite is true, and the lower opening price went from the bottom of the bar to the top, meaning the price appreciated. Sometimes there is a gap between yesterday’s closing price and today’s opening price and that is what a price gap looks like on a price chart.
As you can see there are certain discontinuities or gaps between previous day’s closing prices and opening prices of the next day. Some of them are more noticeable, going against previous day’s trend and some of them are relatively minor.
Price Gaps: How not to blow up your account
Trading on eToro platform has never been so easy. A clear user-friendly interface makes opening, monitoring and closing down trades very easy even for less experienced users. There are also plenty of learning opportunities and possibilities to practice on a demo account before risking your real capital. Yet, some trading technicalities and particularities in which financial markets operate may put your investment journey in danger.
Sometimes to your own surprise you might find yourself in a situation in which you are, for example, placing a buy position with a stop-loss level for protection yet somehow the trade falls right straight through it, so you end up losing much more than you were ever prepared to. Why does this happen? Because of an unfortunate market situation known as a market gap or a gap down, as it is in this case.
🌟 Types of Price Gaps
There are four common types of price gaps that traders should be aware of:
- Common gaps: These gaps are relatively small and frequently occur, with the opening price slightly different from the previous day’s closing price. They do not usually pose significant threats to traders.
- Breakaway gaps: These gaps occur when the price moves over resistance or below support levels, signaling the beginning of a strong trend. Breakaway gaps can be opportunities for traders to benefit from a price trend.
- Runaway/continuation gaps: These gaps happen in the middle of a trend and indicate its continuation in the same direction. They can be profitable opportunities for traders who recognize the trend early.
- Exhaustion: These gaps usually indicate a change in the trend’s dynamic and may signal a reversal. Late traders who enter the market just before the trend’s end often cause exhaustion gaps.
📈 Pros and Cons of Price Gaps
- Price gaps can provide trading opportunities for those who can identify and capitalize on trends.
- Traders can use price gaps to make short-term gains with high-risk strategies.
- Price gaps can lead to unexpected losses, especially when using leverage.
- They can cause stop-loss orders to trigger at undesirable price levels, resulting in greater losses than anticipated.
🛡️ Managing Price Gaps
To minimize the risks associated with price gaps, consider the following strategies:
- Stay informed: Keep up-to-date with news events and earnings reports that could impact your investments. Major economic events can cause significant price gaps, so being aware of these events can help you prepare and adjust your positions accordingly.
- Use stop orders wisely: While stop orders can help protect your investments, price gaps can lead to stopping orders being triggered at unfavorable levels. Consider using stop-limit orders to minimize the risk of executing an order at an unexpected price.
- Monitor technical indicators: Technical analysis can help you identify potential price gaps and trend reversals. Look for patterns, support and resistance levels, and other indicators to make informed investment decisions.
- Implement risk management techniques: Use tools like portfolio diversification, position sizing, and risk-reward ratios to manage the overall risk of your investments. This way, you can minimize the impact of price gaps on your portfolio.
- Practice patience: Resist the urge to jump into a trade based on a price gap. Take your time to analyze the situation, understand the factors driving the gap, and determine if the potential rewards outweigh the risks.
Price gaps are inherent in financial markets and can impact your investments positively and negatively. By understanding the different types of price gaps and implementing effective risk management strategies, you can protect your investments and potentially profit from these market dynamics. Remember to stay informed, practice patience, and use a combination of technical and fundamental analysis to make informed decisions on the eToro platform.
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GENERAL RISK WARNING
- ▸eToro is a multi-asset platform that offers: Stocks, Crypto assets, and CFDs.
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- ▸Copy Trading does not amount to investment advice. The value of your investments may go up or down. Your capital is at risk.
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Author & Expert Trader - Financial Analyst :
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