A Fair Value Gap (FVG) refers to an imbalance in the price action of a financial market, where there is a significant difference between consecutive candlestick wicks or price levels. This gap typically occurs when price moves rapidly in one direction, leaving little or no trading activity in a specific price range. Traders use FVG to identify potential areas where price might retrace to “fill the gap,” ensuring market efficiency and balance.

Understanding Fair Value Gaps

In a balanced market, price action moves in a way that reflects both buyers and sellers participating actively. However, during periods of high volatility or strong momentum, price may skip certain levels, creating an imbalance or “gap” between demand and supply. These gaps are often revisited as the market seeks to restore balance by returning to levels where trading activity was minimal or absent.

Fair Value Gaps can appear on any timeframe but are more significant on higher timeframes (e.g., daily or weekly charts).

Key Features of Fair Value Gaps

1. Rapid Price Movement:
   FVG occurs when price moves quickly, leaving a range of prices without much trading activity.
2. Imbalance in Supply and Demand:
   The gap reflects a temporary imbalance between buyers and sellers in the market.
3. Price Retracement:
   Markets often retrace to fill FVGs, as this process restores efficiency and balance in the price action.
4. Visible on Candlestick Charts:
   FVG is identified between consecutive candlesticks where the wicks of adjacent candles do not overlap.

How to Identify Fair Value Gaps

1. Look for Imbalances:
   Examine candlestick charts and identify areas where the wick of one candle does not overlap with the wick of the adjacent candle.
2. Focus on Higher Timeframes:
   FVGs on daily or weekly charts tend to have a higher probability of being filled compared to those on lower timeframes.
3. Measure the Gap:
   The FVG is the range between the low of the previous candle’s wick and the high of the next candle’s wick (or vice versa for downward gaps).
4. Monitor Price Retracement:
   Watch for price to return to the FVG area, often as part of a pullback or correction.

How Traders Use Fair Value Gaps

1. Entry Points:
   Traders look for FVGs as potential areas where price may retrace, providing an opportunity to enter trades in the direction of the trend.
2. Exit Points:
   FVGs can also be used as target levels for taking profits, as price often revisits these gaps.
3. Trend Continuation:
   When an FVG is filled, traders may use the gap-filling process as confirmation of a trend continuation.
4. Risk Management:
   Stop-loss orders are often placed beyond the FVG to limit risk in case the gap-filling process fails.

Advantages of Using Fair Value Gaps

1. Improved Accuracy:
   FVGs highlight precise price levels where retracements are likely to occur.
2. Works on Multiple Timeframes:
   FVGs are visible across various timeframes, making them versatile for different trading strategies.
3. Combines Well with Other Indicators:
   FVGs can be used alongside support and resistance, Fibonacci retracement, and volume analysis to strengthen trade setups.
4. Identifies Market Imbalances:
   Helps traders understand areas of inefficiency in price action.

Disadvantages of Fair Value Gaps

1. No Guarantee of Gap Filling:
   Not all FVGs are filled, especially in strongly trending markets.
2. Subjectivity:
   Identifying FVGs can be subjective and depends on the trader’s interpretation of candlestick patterns.
3. Best on Higher Timeframes:
   FVGs on lower timeframes may result in false signals due to market noise.
4. Requires Complementary Tools:
   Relying solely on FVGs may lead to inaccurate trades; additional technical indicators are recommended.

Example of Fair Value Gap

Assume a stock experiences a strong upward move:

• Candle 1 closes at $50.
• Candle 2 opens at $55 and closes at $60, leaving a gap between $50 and $55 with no overlap.
  This $5 range is the Fair Value Gap, as price moved too quickly without much trading activity.

If the stock later retraces to the $50–$55 range, traders might consider this a potential buying opportunity before the price continues upward.

FAQs

What is a Fair Value Gap (FVG)?
An FVG is an area in price action where trading activity is minimal or absent due to rapid price movement, creating an imbalance between buyers and sellers.

How do traders use FVGs?
Traders use FVGs to identify potential retracement levels, entry points, and targets for taking profits.

Do all Fair Value Gaps get filled?
No, not all FVGs are filled, especially in strong trends where price may not return to the gap.

On which timeframes are FVGs most effective?
FVGs are more reliable on higher timeframes, such as daily or weekly charts, compared to lower timeframes.

How do you calculate the size of an FVG?
The size of an FVG is the difference between the low of one candle’s wick and the high of the adjacent candle’s wick (or vice versa).

What causes Fair Value Gaps?
FVGs occur due to rapid price movement, often driven by high volatility, news events, or strong momentum in the market.

Can FVGs be used with other indicators?
Yes, FVGs are often combined with Fibonacci retracement, support and resistance, or volume analysis for better accuracy.

Are FVGs visible in all markets?
Yes, FVGs can be identified in stocks, forex, cryptocurrencies, and other financial markets.

Is FVG analysis subjective?
Yes, identifying FVGs can be subjective and depends on the trader’s interpretation of candlestick patterns and price action.

What are the risks of trading based on FVGs?
The main risks include false signals, reliance on incomplete patterns, and market conditions that prevent gaps from being filled.

Fair Value Gaps are a valuable tool for traders looking to identify market inefficiencies and potential retracement levels. While not all FVGs are filled, combining this technique with other technical analysis tools can enhance its effectiveness and improve trading outcomes.