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

A Fair Value Gap (FVG) is a concept in financial market trading that serves as a tool in technical analysis. It represents an area on a price chart where the market has moved rapidly in one direction, leaving behind an imbalance or inefficiency. Traders analyze these gaps to understand potential future price movements, as they indicate incomplete price discovery due to swift market action.

Understanding Fair Value Gaps

A Fair Value Gap (FVG) represents a price inefficiency or an imbalance between buying and selling pressure. These gaps appear on a price chart as a void, indicating a range where minimal or no trading occurred due to rapid price movement. Markets naturally seek equilibrium, and FVGs highlight areas where price has deviated from a balanced state, implying the market may eventually return to “fill” or rebalance these areas.

An FVG is often characterized as a liquidity void or an untraded zone, signifying the market rushed through a price range without sufficient orders being matched. Intense buying or selling pressure causes sharp price movements, resulting in price skipping levels. These gaps are distinct from common gaps, which often occur overnight or between trading sessions. FVGs specifically highlight areas of supply and demand imbalance.

Formation and Identification of FVGs

Fair Value Gaps are identified through a specific three-candlestick pattern. For a bullish FVG, the high of the first candlestick’s wick does not overlap with the low of the third candlestick’s wick. The void between these two wicks, encompassing the middle candlestick, forms the bullish FVG. This indicates strong buying pressure caused an aggressive upward price move, leaving an area where transactions were not fully executed.

Conversely, a bearish FVG forms when the low of the first candlestick’s wick does not overlap with the high of the third candlestick’s wick. The space between these wicks marks the bearish FVG, indicating intense selling pressure caused a rapid downward price movement that bypassed certain price levels. In both bullish and bearish scenarios, the middle candlestick in the three-candle sequence is often a large, impulsive candle that creates the imbalance. Traders can manually identify these gaps or use specialized indicators that highlight them on the chart.

Market Significance of FVGs

Fair Value Gaps are considered significant by traders because they indicate areas of market inefficiency that price tends to revisit. Price often acts as a “magnet,” returning to “fill” or rebalance these gaps before potentially continuing its original trend. This tendency is rooted in the market’s natural inclination to seek equilibrium.

These gaps can serve as areas of interest for future price interaction, acting as potential support or resistance levels. The formation of FVGs is often linked to underlying market dynamics, such as institutional trading activity and order flow. Large institutional orders can cause rapid price movements that create these imbalances, as the market reprices assets swiftly. Recognizing these gaps can provide insights into where significant market participants may be influencing price. The presence of an FVG can also confirm the strength of an existing trend, suggesting continued momentum in that direction.

Practical Application of FVGs in Trading

Traders utilize Fair Value Gaps in various trading strategies. A common approach uses FVGs as potential support or resistance zones where price might react. For instance, a bullish FVG might see price retrace into it for support, while a bearish FVG could act as resistance. These gaps can also serve as precise entry and exit points, allowing traders to capitalize on the market’s tendency to revisit inefficient zones.

FVGs are often combined with other technical analysis tools for robust trading setups and confluence. Traders integrate FVG analysis with trendlines, moving averages, or order blocks to confirm ideas. An FVG within an established trend or near a significant order block strengthens trade conviction. Placing a stop-loss order just beyond the FVG boundary is a common risk management technique, as a move past this level may invalidate its significance. FVGs on higher timeframes, like daily or weekly charts, have greater significance and may attract price longer.