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The Fair Value Gap (FVG)
The term "fair value gap" is known by various names among price action traders, including imbalance, inefficiency, and liquidity void. But what do these imbalances mean? They arise when the forces of buying and selling exert considerable pressure, resulting in sharp and rapid price movements.
On a chart, a Fair Value Gap appears as a three-candlestick pattern. In a bullish context, an FVG forms when the top wick of the first candlestick does not connect with the bottom wick of the third candlestick. Conversely, in a bearish scenario, the FVG is created when the bottom wick of the first candlestick fails to connect with the top wick of the third candlestick. The gap on the middle candlestick, created by the wicks of the first and third candlesticks, represents the Fair Value Gap.
The concept of FVG trading is based on the idea that the market has a natural tendency to self-correct. These price discrepancies or inefficiencies are generally not sustainable over time, and the market often returns to these gaps before continuing in the same direction as the original impulsive move.
What are the Types of Fair Value Gaps?
1. Bearish Fair Value Gap
A bearish Fair Value Gap occurs when there is a space between the bottom wick of the first candlestick and the top wick of the third candlestick. This gap typically appears on the body of the middle candlestick, and the individual characteristics of each candlestick are not particularly important. What’s crucial in a bearish scenario is that the gap on the middle candlestick results from the wicks of the surrounding candlesticks not connecting.
2. Bullish Fair Value Gap
A bullish Fair Value Gap occurs when the top wick of the first candlestick does not connect with the bottom wick of the third candlestick. In this case, the specific direction of each candlestick is not as important. What really matters is that there is a gap in the middle candlestick, where the wicks of the first and third candlesticks have not linked.
3. Inverse Fair Value Gap
An Inverse Fair Value Gap is an FVG that has lost its validity in one direction but remains significant enough to influence price movement in the opposite direction. For example, a bullish FVG is deemed invalid if it fails to act as a demand zone. However, it then transforms into an inverse bearish FVG, which may serve as a supply zone capable of holding the price.
4. Implied Fair Value Gap
The Implied Fair Value Gap is also a three-candlestick pattern, but it does not feature a gap on the middle candlestick, which is why it’s called an “implied FVG.” Instead, it consists of a larger middle candle flanked by two relatively long wicks from the first and third candles.
The “gap” is defined by marking the midpoint of the wick of the first candlestick that touches the middle candle and the midpoint of the wick of the third candle that also touches the middle candle. These two midpoints create the gap.
Here are some factors that can lead to the formation of fair value gaps:
1. Economic Data Releases
Key economic data releases, such as changes in interest rates or unemployment statistics, can similarly create imbalances. If the data surprises the market, it can trigger a swift price movement in one direction, resulting in a gap.
2. Sudden News Events
Unexpected news that significantly affects market sentiment can lead to a rapid increase in buying or selling activity, resulting in a gap as prices adjust to the new information. For instance, if a company unexpectedly reports strong earnings, its stock price may surge, creating a gap on the chart.
3. Market Openings or Closings
Gaps may form during periods of low liquidity, such as at market openings or closings. With fewer market participants, even a small amount of buying or selling can cause a noticeable price jump that isn’t quickly countered.
4. Large Institutional Trades
Significant trades by institutional investors can also lead to fair value gaps (FVGs). When a hedge fund or financial institution executes a large buy or sell order, it can overwhelm the existing order book, causing a rapid price shift and leaving a gap behind.
5. Weekend Gaps
FVG's are often observed between the close on Friday and the open on Monday, reflecting news or events that occurred over the weekend.
KEY POINTS TO KNOW
- Fair Value Gaps (FVGs) are powerful tools traders use to identify market imbalances and inefficiencies.
- FVGs occur when buying or selling pressure leads to significant price movements, leaving behind gaps on price charts.
- FVGs can be identified through technical analysis involving the analysis of candlestick patterns and price chart patterns.
- Traders can categorize FVGs into two types: Undervalued FVGs, where prices are lower than fair value, and Overrated FVGs, where prices are higher.
On a chart, a Fair Value Gap appears as a three-candlestick pattern. In a bullish context, an FVG forms when the top wick of the first candlestick does not connect with the bottom wick of the third candlestick. Conversely, in a bearish scenario, the FVG is created when the bottom wick of the first candlestick fails to connect with the top wick of the third candlestick. The gap on the middle candlestick, created by the wicks of the first and third candlesticks, represents the Fair Value Gap.
The concept of FVG trading is based on the idea that the market has a natural tendency to self-correct. These price discrepancies or inefficiencies are generally not sustainable over time, and the market often returns to these gaps before continuing in the same direction as the original impulsive move.
What are the Types of Fair Value Gaps?
1. Bearish Fair Value Gap
A bearish Fair Value Gap occurs when there is a space between the bottom wick of the first candlestick and the top wick of the third candlestick. This gap typically appears on the body of the middle candlestick, and the individual characteristics of each candlestick are not particularly important. What’s crucial in a bearish scenario is that the gap on the middle candlestick results from the wicks of the surrounding candlesticks not connecting.
2. Bullish Fair Value Gap
A bullish Fair Value Gap occurs when the top wick of the first candlestick does not connect with the bottom wick of the third candlestick. In this case, the specific direction of each candlestick is not as important. What really matters is that there is a gap in the middle candlestick, where the wicks of the first and third candlesticks have not linked.
3. Inverse Fair Value Gap
An Inverse Fair Value Gap is an FVG that has lost its validity in one direction but remains significant enough to influence price movement in the opposite direction. For example, a bullish FVG is deemed invalid if it fails to act as a demand zone. However, it then transforms into an inverse bearish FVG, which may serve as a supply zone capable of holding the price.
4. Implied Fair Value Gap
The Implied Fair Value Gap is also a three-candlestick pattern, but it does not feature a gap on the middle candlestick, which is why it’s called an “implied FVG.” Instead, it consists of a larger middle candle flanked by two relatively long wicks from the first and third candles.
The “gap” is defined by marking the midpoint of the wick of the first candlestick that touches the middle candle and the midpoint of the wick of the third candle that also touches the middle candle. These two midpoints create the gap.
Here are some factors that can lead to the formation of fair value gaps:
1. Economic Data Releases
Key economic data releases, such as changes in interest rates or unemployment statistics, can similarly create imbalances. If the data surprises the market, it can trigger a swift price movement in one direction, resulting in a gap.
2. Sudden News Events
Unexpected news that significantly affects market sentiment can lead to a rapid increase in buying or selling activity, resulting in a gap as prices adjust to the new information. For instance, if a company unexpectedly reports strong earnings, its stock price may surge, creating a gap on the chart.
3. Market Openings or Closings
Gaps may form during periods of low liquidity, such as at market openings or closings. With fewer market participants, even a small amount of buying or selling can cause a noticeable price jump that isn’t quickly countered.
4. Large Institutional Trades
Significant trades by institutional investors can also lead to fair value gaps (FVGs). When a hedge fund or financial institution executes a large buy or sell order, it can overwhelm the existing order book, causing a rapid price shift and leaving a gap behind.
5. Weekend Gaps
FVG's are often observed between the close on Friday and the open on Monday, reflecting news or events that occurred over the weekend.
KEY POINTS TO KNOW
- Fair Value Gaps (FVGs) are powerful tools traders use to identify market imbalances and inefficiencies.
- FVGs occur when buying or selling pressure leads to significant price movements, leaving behind gaps on price charts.
- FVGs can be identified through technical analysis involving the analysis of candlestick patterns and price chart patterns.
- Traders can categorize FVGs into two types: Undervalued FVGs, where prices are lower than fair value, and Overrated FVGs, where prices are higher.
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