What Is a Fair Value Gap (FVG) in Trading?

A Fair Value Gap (FVG) is a concept used in technical analysis to identify areas on a price chart where market inefficiencies or imbalances have occurred. This analytical tool helps traders understand underlying price action by pinpointing zones where buying and selling pressure were not equal. The presence of an FVG suggests a rapid, one-sided price movement, leaving behind a void that the market may eventually revisit to address such imbalances.

Core Concept of Fair Value Gap

A Fair Value Gap represents an area on a price chart where a significant imbalance between buying and selling pressure has led to a rapid price movement. This swift action creates an “inefficiency” or “void” in the market, as price moved quickly without sufficient counter-party interaction. The formation of an FVG is identified using a specific three-candlestick pattern. For a bullish FVG, there is an empty space between the high of the first candlestick and the low of the third candlestick. Conversely, a bearish FVG forms when there is a gap between the low of the first candlestick and the high of the third candlestick.

The middle candlestick in this three-candle sequence typically shows a strong, impulsive move, indicating aggressive buying or selling activity. This untraded zone signifies a moment where price accelerated, skipping over certain levels due to a sudden surge in demand or supply, leaving behind a clear area of market imbalance.

Visual Identification on Charts

Identifying a Fair Value Gap on a price chart involves looking for a distinct three-candlestick pattern. For a bullish FVG, observe a rapid upward price movement where the high of the first candle in the sequence does not overlap with the low of the third candle. For a bearish FVG, look for a sharp downward price move where the low of the first candle does not overlap with the high of the third candle. Traders can manually draw a box or line to mark this specific zone on their charts, or they can utilize automated indicators available on many trading platforms that highlight these gaps for easier visual recognition.

Market Interpretation of Fair Value Gaps

Fair Value Gaps signify market inefficiency or a liquidity void. These gaps suggest that price moved quickly in one direction, leading to insufficient trading at certain levels and creating an imbalance. Because markets tend to seek equilibrium, these untraded zones often act as potential “magnets” for future price action. Price may revisit these areas to “fill” the gap, effectively rebalancing the market by facilitating trading at previously skipped levels.

A bullish FVG indicates that buyers were highly aggressive, where demand significantly outstripped supply. Conversely, a bearish FVG suggests that sellers were dominant, where supply overwhelmed demand. When price revisits a bullish FVG, it can act as a potential support zone. A bearish FVG can serve as a resistance zone, allowing traders to interpret FVGs as significant price levels that may influence future market movements.

Strategic Integration in Trading

Traders incorporate Fair Value Gaps into their strategies by using them in conjunction with other technical analysis tools. These gaps can serve as potential areas for identifying precise entry points, particularly when price returns to “fill” the gap. For instance, in an uptrend, a trader might wait for price to retrace into a bullish FVG before considering a long entry, expecting the FVG to act as support. Similarly, in a downtrend, a retracement into a bearish FVG could signal a potential short entry, with the FVG acting as resistance.

FVGs are also used for setting profit targets or placing stop-loss orders. A stop-loss might be placed just beyond the FVG zone, limiting potential losses if the market does not react as anticipated. Profit targets can be identified by projecting price movement once the gap is filled and the original trend resumes. Combining FVGs with other indicators like Fibonacci retracement levels or order blocks can enhance the probability of a successful trade setup, as multiple confirmations strengthen the signal. This comprehensive approach helps traders make more informed decisions.