Review of Gap Theory and FX Outlook

In a 24-hour a day market like foreign exchange and especially a currency pair like the euro-dollar exchange rate where daily turnover is estimated at nearly $1 trillion a day, gaps in the price action are rare.

There are different types of gaps and they are associated with different market conditions. Given that the euro and Swiss gaps remain unfilled, it may be helpful to review what market technicians refer to as gap theory.

There are four general types of gaps. There are normal gaps that get filled relatively quickly. This is what happened today to the Australian dollar and British pound and also the German Dax, for example.

There are measuring gaps that may be seen near half way through a pattern. The gap is not quickly filled and points to a new price target.

There are break away gaps that typically gap through a trend line or support/resistance. Such a gap signals the start of a significant move.

Lastly, there are exhaustion gaps. These take place at the end of a move and is if the last buyers/sellers have shown their hand is really part of a reversal pattern.

The euro and Swiss franc gaps have not been filled. The euro's gap extends from today's high (now roughly $1.3060) to last Friday's lows (~$1.3080). The dollar's gap against the Swiss franc extends from today's low (now roughly CHF0.9198) to last Friday's high (~CHF0.9185).

Our working assumption is that the gaps in the euro and Swiss franc are normal gaps and will be closed in the near-term. After the gaps are closed, we look for the dollar's recovery to resume.