The Fair Value Gap is a popular strategy used by price action traders as an essential building block for their technical analysis. This strategy is relatively easy to use, which makes it ideal for both beginners and expert traders for planning trades. In this post, we will delve into what this popular price pattern entails and how to trade with it effectively.
What Is FVG In Trading?
A Fair Value Gap (FVG) is a jump in price movement caused by an imbalance between buying and selling pressure. Also known as a Price Value Gap or simply “imbalance,” a Fair Value gap is formed when the price of an asset moves too quickly towards lower demand or higher supply as the case may be. On a trading chart, the Fair Value Gap represents the point where this rapid jump in price occurred.
A Fair Value Gap can be caused by various factors including major economic news or important events, economic report publications, large institutional trades, and sudden shifts in market sentiments.
On a trading chart, a Fair Value Gap is shown by a triple candle pattern that consists of a large candle whose body doesn’t overlap with the wicks of the previous candle and the one that follows it. The space between these wicks is the actual Fair Value Gap.
Fair Value Gap Indicator
A Fair Value Gap can be identified manually by looking out for the triple candle pattern or by using a Fair Value Gap indicator. The Fair Value Gap (FVG) indicator is a technical analysis tool. This tool does not give clear trade entry signals, but it can help identify areas on a trading chart where there is a significant jump in price. Since an FVG is considered an area of imbalance and can be used to pick out trading opportunities, an FVG indicator is a valuable tool for finding this balance.
The indicator generally works by looking out for large candlesticks that do not overlap other candlesticks on either side. When this tool identifies the gap, it plots a horizontal triangle over it on the chart. This rectangle can be used as a buy signal in an uptrend or a sell signal in a downtrending market.
Identifying Fair Value Gaps: Bullish Fair Value Gap
A Fair Value Gap is said to be bullish when it indicates a potential upward price movement due to a surge in buying pressure. This is typically triggered by positive economic news, great earnings reports, and a sudden shift in market sentiments toward optimism.
On a chart, a bullish Fair Value Gap is shown by a gap between the highest point of the wick of the first candle and the lowest point of the wick of the third candle. This gap indicates a potential upward price momentum with good buying opportunities for traders.
Identifying Fair Value Gaps: Bearish Fair Value Gap
A bearish Fair Value Gap signifies a strong surge in selling pressure which causes prices to drop quickly. This is caused by factors like negative economic news, disappointing earnings reports, and sudden changes in market sentiments toward pessimism.
A Bearish Fair Value Gap is typically identified by a gap between the lowest point of the first candle’s wick and the highest point of the third candle’s wick. This gap is formed within the body of the middle candlestick due to a lack of connection between the wicks of these two candles. This is taken as an indicator of potential downward pressure.
Identifying Fair Value Gaps: Inverse Fair Value Gap
An Inverse Fair Value Gap occurs when a pre-existing FVG becomes invalidated due to a shift in market sentiments. When this happens, the role of the FVG flips, indicating that the price action has moved in a way that is contradictory to what the original FVG suggested. For instance, a bearish FVG can be invalidated by a price breakout to become a bullish inverse Fair Value Gap.
The first step in identifying an IFVG is to find the standard Fair Value Gap using the three-candle pattern as described above. This can be either bullish or bearish as the case may be. Next, you have to observe the price movement to see if it moves through and closes beyond the established FVG. The direction of the break determines if the inverse FVG is now bullish or bearish.
Pros And Cons Of Fair Value Gaps
Just like any other strategy, trading with a Fair Value Gap has both its advantages and downsides. The pros and cons of using FVG in trading are analyzed below:
Pros
- Profit potential: An accurate and successful application of a Fair Value Gap can potentially lead to significant profits.
- Reduced risk: Using FVG to inform trading decisions involves focusing on identifying market inefficiencies. This is generally less risky compared to other strategies that require you to bet on the direction of the price movement.
- Improved Market Timing: the main idea of FVG trading is to identify optimal levels where traders can enter and exit trades,
- Flexibility: FVG is a flexible strategy that can be applied to a wide range of assets. It can also be used as part of different trading strategies and works for all time frames.
Cons
- Risk of misjudgment: The main premise of using this strategy for trading is the assumption that price will reverse to fill the gap. But this isn’t always the case. In some cases, gaps may not be filled as anticipated, leading to potential losses.
- Limited opportunities: since the FVG is based on market imbalances, a trader’s chances of using this strategy successfully may be limited in highly efficient markets.
- Requires patience: when using this strategy, traders have to return for the price to return to fill the gap. This requires significant patience because it might take time.
Fair Value Gap Trading Strategy
A Fair Value Gap is a kind of imbalance in market conditions. It indicates a situation where the price of an asset has deviated from its fair value, However, since the market generally tends to return to its true value, one can take advantage of this indicator to make potentially profitable trading decisions.
To trade with this strategy, look out for a specific pattern on the chart where a large price movement creates a gap that the following candle does not fully cover. This is the FVG. Once the gap has been identified, the next step is to wait for the price to move back toward the gap and fill it. You can then make a trade based on the direction of the price movement.
For instance, say the price of an asset was moving up before the gap was created, a trader can make a buying decision when the price returns to fill the gap based on the expectation that the price will move up again.
To use FVG effectively in your trading strategy, there are some essential tips to keep in mind. They include:
- The market might not always follow the anticipated pattern, so always use risk management techniques like stop loss in order to protect yourself.
- Use a combination of indicators.
- Before entering a trade, always wait for confirmation that the original trend will continue after the FVG is filled.
- If the FVG is close to an area where liquidity can be picked, wait for this to happen before entering a trade.
FAQs About FVG
What is Fair Value Gap in trading
A Fair Value Gap (FVG) is a price gap that occurs due to an imbalance between demand and supply, causing a significant gap in the price of an asset. The rapid price movement causes the price to skip over certain price levels, creating a gap where no trades occur.
How to Find Fair Value Gap
You can find a Fair Value Gap on a trading chart by either looking out for the triple candle pattern or by using a Fair Value Gap indicator.
What does a Fair Value Gap look like
The Fair Value Gap appears on a chart as a gap between three candles. The key to identifying this pattern is to look for a pattern where the high of the first candle and the low of the third candle are not fully covered by the large candle between them. This essentially leaves a “blank space” on the chart.
