In the world of technical analysis, chart patterns, and price action strategies, traders often look for inefficiencies in price movements to find high-probability setups. One such concept that’s gaining popularity among smart traders is the Fair Value Gap (FVG). If you’ve ever seen a sudden burst in price movement and wondered what happened in between, you’ve likely spotted an FVG.
In this blog, we’ll break down what is Fair Value Gap, how it works, and how to identify it, with real-world examples to help you see the gaps in your trading knowledge literally.
What does Fair Value Gap (FVG) Mean?
Let’s start with the fair value gap meaning in simple terms. An FVG is a price imbalance that occurs when the market moves so quickly in one direction that certain price levels get skipped over. These unfilled zones are considered “gaps” and often attract price action back to them in the future.
Fair Value Gap Definition:
A fair value gap (FVG) is a price range between two candles on a chart where there was no trading activity, usually caused by a large, fast-moving candle. These gaps are considered areas where the market didn’t have time to react properly, hence the “unfair” pricing.
Fair Value Gaps in Different Markets
Fair Value Gaps (FVGs) are price ranges on charts where minimal trading occurs due to sudden, strong moves caused by imbalances between buyers and sellers. These gaps are found across various markets, including equities, commodities, and currencies. In the stock market, FVGs often appear after major news events, earnings announcements, or institutional trades, creating zones where price may later return as the market seeks equilibrium. In currency and commodity markets, FVGs frequently result from macroeconomic data releases, geopolitical events, or unexpected policy changes, leading to sharp price jumps and skipped levels. Traders in all these markets use FVGs to identify potential entry and exit points, anticipating that prices will “fill” these gaps before resuming their original trend. Understanding FVGs helps traders spot high-probability setups and manage risk more effectively.
How to Spot a Fair Value Gap on Charts?
Spotting a fair value gap isn’t rocket science, but it does take a trained eye. Generally, it involves analysing three consecutive candlesticks.
Here’s how you do it:
- Look for Large Candles: FVGs are typically formed when there’s a big bullish or bearish move, leading to a strong candle.
- Three-Candle Structure:
- For a bullish FVG: The low of the first candle is higher than the high of the third candle.
- For a bearish FVG: The high of the first candle is lower than the low of the third candle.
- No Price Overlap: There should be a visible “gap” where the price didn’t revisit the skipped area between the first and third candles.
These areas often act like magnets for the price to revisit them, offering traders a potential entry or exit point.
How do Traders Use Fair Value Gaps to Their Advantage?
Many traders incorporate fair value gaps as part of their price action trading strategies. Here’s how they typically use them:
- Entry Points
Traders often wait for prices to revisit the FVG zone and then look for confirmation signals to enter trades. It allows for precision in timing and better risk-to-reward ratios.
- Reversal or Continuation Confirmation
If the price returns to fill the gap and bounces, it can confirm a continuation. On the flip side, failure to respect the FVG could signal a trend reversal.
- Risk Management
FVGs also help with risk management. By placing stop-loss levels just beyond the FVG, traders can minimise their downside if the trade doesn’t go in their favour.
- Combining with Other Indicators
Some traders combine FVGs with interest rate news, support-resistance levels, or trend indicators to refine their trading decisions.
Fair Value Gap in Action: A Simple Example
Let’s look at a simple FVG example:
Suppose a stock is trading at ₹100 and suddenly jumps to ₹110 with a large green candle due to strong earnings news. The next candle opens at ₹111 and goes up to ₹115. The price action has left behind a bullish fair value gap between ₹100 and ₹110.
Now, even if the price continues to ₹130, chances are, it may return to the ₹100-₹110 zone to “fill” the gap. Traders watch this area closely to enter buying or selling positions depending on market conditions.
Should You Consider Trading Fair Value Gaps?
Trading fair value gaps can be a powerful strategy, but it’s not foolproof. Here are a few things to keep in mind:
Pros:
- Offers precise entry zones
- Helps understand price inefficiencies
- Works well in volatile markets
Cons:
- FVGs don’t always get filled
- May generate false signals in choppy markets
- Requires patience and proper trading strategies
Before jumping in, it’s essential to test the method with a demo account and pair it with solid risk management practices.
Conclusion
The concept of the fair value gap might sound technical, but it’s simply about identifying unbalanced price zones where the market moved too quickly. Understanding these gaps can help traders make smarter decisions, especially in fast-moving markets.
Whether it’s a bullish FVG after a breakout or a bearish FVG during a sell-off, recognising and using these price gaps can add another edge to your trading playbook. Just remember, not every gap gets filled, and no strategy is 100% foolproof. But with the right tools and mindset, FVGs can be a great addition to your trading arsenal.
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