What Is a FVG and How Is It Used in Trading?

A Fair Value Gap (FVG) is a concept in financial markets and technical analysis. It describes an area on a price chart where an imbalance between buying and selling pressure creates a temporary market inefficiency. This temporary inefficiency can set the stage for potential future price movements.

Understanding Fair Value Gaps

A Fair Value Gap, often called an “imbalance” or “inefficiency,” occurs when an asset’s price moves rapidly in one direction. This rapid movement leaves a void in traded prices, indicating aggressive market participants without enough opposing orders for efficient price discovery. Such a gap means the market did not thoroughly trade at certain price levels, so fair value was not adequately established.

These imbalances are significant because they reveal areas where liquidity was insufficient to absorb the aggressive directional flow of orders. The market naturally seeks balance, and these untraded zones suggest a deviation from true fair value.

Identifying Fair Value Gaps on Charts

Identifying Fair Value Gaps on a trading chart involves recognizing a specific visual pattern formed by three consecutive candlesticks. For a bullish FVG, locate a strong upward-moving middle candle that has caused price to advance quickly. Then, observe the high of the first candle and the low of the third candle. A bullish FVG exists if the low of the third candle is higher than the high of the first candle, creating an empty space that the middle candle’s body or wicks do not fill. This empty space visually represents the fair value gap.

Similarly, for a bearish FVG, look for a strong downward-moving middle candle. Examine the low of the first candle and the high of the third candle. A bearish FVG is present if the high of the third candle is lower than the low of the first candle, leaving an untraded zone. This visual void indicates a rapid price decline where insufficient opposing interest was present.

These gaps appear as clear empty spaces on candlestick charts, distinguishing them from traditional price gaps that often occur between trading sessions. Recognizing these specific patterns is a practical step for traders to pinpoint areas of market imbalance.

The Role of Fair Value Gaps in Price Action

Fair Value Gaps play a significant role in interpreting market dynamics, as their presence implies an underlying imbalance between supply and demand. These gaps highlight zones where price moved with such speed that orders were not fully matched, leading to an area of market inefficiency. The market often has a tendency to revisit these inefficient zones to “rebalance” or “fill” the gap, seeking equilibrium over time.

Traders commonly interpret FVGs as potential areas where price might reverse, continue its trend, or consolidate as it seeks to re-establish fair value. For instance, if a bullish FVG forms, price might later retrace into this gap before continuing its upward movement, as if to “fill” the void left by the initial rapid ascent. Conversely, a bearish FVG might see price temporarily recover into the gap before resuming its decline. This behavior suggests that these gaps can act as magnets for price, drawing it back to address the previous imbalance.

FVGs are often seen as footprints of significant institutional activity, sometimes referred to as “smart money concepts.” Large orders from institutional players can cause these rapid price movements, leaving behind these areas of market inefficiency. Traders utilize FVGs to identify potential entry and exit points, as well as to confirm the strength of a trend. Price will eventually return to these areas to collect liquidity and balance the order flow, providing insights into future price behavior.