What Is a Fair Value Gap & How to Use It for Trading?

Fair Value Gaps (FVGs) represent a concept in technical analysis that many traders use to identify potential market inefficiencies. This approach focuses on specific patterns on price charts, suggesting areas where buying and selling pressure have been imbalanced. Understanding FVGs can provide insights into potential future price movements, as they are often viewed as zones that the market may revisit. Traders use this concept to identify opportunities.

Defining Fair Value Gaps

A Fair Value Gap represents a specific area on a candlestick chart where price has moved quickly in one direction, creating a “void” in price delivery. This void signifies an imbalance between buyers and sellers, indicating that the price was not “fairly” exchanged across a certain range. It typically forms within a three-candle pattern, where the wicks of the first and third candles do not overlap, leaving the middle candle’s range exposed.

The underlying concept behind a Fair Value Gap is market inefficiency, or a liquidity void. When price moves rapidly, often due to significant institutional order flow, there may not be enough opposing orders to facilitate a smooth price transition. This swift movement leaves behind a segment on the chart where transactions did not occur, creating an “imbalance” that the market may eventually seek to “fill” or “rebalance.” Such areas can act as magnets for future price action, drawing price back into the inefficient zone.

Identifying Fair Value Gaps on Price Charts

Identifying a Fair Value Gap on a candlestick chart involves recognizing a specific three-candle formation. For a bullish Fair Value Gap, look for three consecutive candles where the price has moved significantly upward. The key characteristic is that the high of the first candle’s wick does not overlap with the low of the third candle’s wick. The space between these two points, encompassing part of the second candle’s range, constitutes the bullish Fair Value Gap.

Conversely, a bearish Fair Value Gap forms during a strong downward price movement. In this three-candle sequence, the low of the first candle’s wick will not overlap with the high of the third candle’s wick. The resulting empty space between these wicks, within the range of the middle candle, represents the bearish Fair Value Gap. Traders often use a rectangular drawing tool to mark these identified areas on their charts, extending the zone horizontally to monitor future price interaction.

The Significance of Fair Value Gaps in Trading

The theory suggests that markets tend to seek equilibrium, and thus, price often revisits these “unfilled” zones to reprice assets more thoroughly. This tendency for price to return to the gap is often referred to as “filling” or “rebalancing” the inefficiency. These areas can then act as potential levels of support or resistance.

The presence of a Fair Value Gap can suggest that significant institutional order flow occurred rapidly, leaving a footprint on the chart. Such large-scale movements create a vacuum in price delivery, which the market may later attempt to correct. Therefore, FVGs are often seen as “price magnets” or “liquidity pools,” attracting future price action back into these zones.

Using Fair Value Gaps in Trading Strategies

Traders often incorporate Fair Value Gaps into their strategies by using them as potential entry points. For instance, after a strong move creates an FVG, a trader might wait for price to retrace back into the gap before initiating a trade in the direction of the original strong move. FVGs can also serve as areas for placing stop-losses, typically positioned just beyond the FVG zone to manage risk.

Fair Value Gaps are rarely used as a standalone indicator. Instead, traders often combine them with other technical analysis tools and concepts, such as market structure, liquidity zones, or analysis of higher timeframes. This confluence of indicators helps to confirm trade ideas and increase the probability of successful outcomes. While FVGs pinpoint areas of potential interest, they do not guarantee future price movement and require integration into a comprehensive trading plan that includes robust risk management.