What Is a Fair Value Gap in Trading?

Technical analysis in trading involves observing past price movements and patterns to understand market behavior. Traders analyze price charts to identify clues about supply and demand dynamics. Within this analytical framework, certain patterns emerge that highlight areas of market inefficiency. One such pattern is the fair value gap, which provides specific insights into moments where price delivery might have been incomplete. These gaps signify particular areas on a price chart that can indicate underlying market conditions.

Defining a Fair Value Gap

A fair value gap (FVG) represents an area on a price chart where market transactions were not efficiently balanced, often called an “imbalance” or “inefficiency.” This occurs when price moves rapidly in one direction, leaving a void where insufficient trading activity took place to establish a balanced price. Conceptually, an FVG indicates a point where price delivery was quick, without sufficient opposing orders to create a thoroughly traded range.

The visual representation of an FVG typically involves a specific three-candle pattern. This pattern shows a space between the wick of the first candle and the wick of the third candle, with the middle candle exhibiting a significant directional move. This “gap” highlights an area where price moved so quickly that it bypassed certain levels, leaving an inefficiently delivered price zone. The rapid movement suggests the market did not have enough time for balanced transactions, leading to this distinct imbalance.

Identifying Fair Value Gaps on Price Charts

Identifying a fair value gap on a price chart involves looking for a specific three-candle formation. Traders look for three consecutive candlesticks where the wicks of the first and third candles do not fully overlap, creating an empty space.

For a bullish fair value gap, locate three successive candles where the low of the first candle’s wick does not connect with the high of the third candle’s wick. The space between these two wicks, encompassing the second candle, signifies the bullish FVG. Conversely, a bearish FVG appears when the high of the first candle’s wick does not overlap with the low of the third candle’s wick. The void remaining between these two points marks the bearish FVG. Once identified, the boundaries are typically marked from the high or low of the first candle’s wick to the low or high of the third candle’s wick, depending on the gap’s direction.

Market Imbalances and Fair Value Gap Formation

Fair value gaps form due to significant and rapid buying or selling pressure that causes price to move swiftly in one direction. These abrupt movements often arise from a substantial disparity between buyers and sellers, leading to one side overwhelming the other. This imbalance results in inefficient price delivery because the market does not have time to conduct balanced transactions at every price level.

Such rapid price action occurs when liquidity is thin on one side of the market. For instance, a sudden influx of large institutional orders or a major news event can trigger a quick price jump or drop, as the market scrambles to find enough opposing orders. This process leaves certain price levels untraded or minimally traded, creating the visible gap on the chart. The resulting FVG is a direct consequence of this aggressive, one-sided market movement.

Interpreting Fair Value Gaps in Market Structure

Fair value gaps are often regarded as areas of “inefficiency” or “liquidity voids” that the market may eventually seek to “fill” or rebalance. These gaps signify zones where price discovery was incomplete. The market’s tendency to return to these areas suggests a drive towards seeking balance.

The presence of an FVG can indicate where price might return to “re-test” or consolidate before continuing its trend. They act as significant areas of interest, signaling that the market may revisit these untraded levels. This reflects the market’s underlying drive to achieve efficiency and rebalance supply and demand.