Fair value gaps represent a critical concept for price action trading since they highlight moments in which the market can move rapidly and this results in price inefficiencies.
Many traders incorporate fair value gaps into their strategies to identify potential entry points with higher probability of success.
This article will provide a structured overview of fair value gaps, discuss how to spot them, and explain practical ways of using fair value gaps for entry points to enhance your trading decisions.
What Are Fair Value Gaps?
Fair value gaps occur when price moves sharply toward one direction.
Market participants did not fully transact in those chart areas so these gaps are created.
These gaps reflect temporary imbalances between supply and demand, often caused by powerful buying or selling activity typically by large institutional players.
Prices will often revisit these gaps so as to “fill” the inefficiency before continuing along their trend, for the market has a tendency to seek equilibrium.
How to Identify Fair Value Gaps
Fair value gaps are mainly identified by observing a specific three-candle pattern on a candlestick chart:
- Candle One: Initiates a price range.
- Candle Two: A large momentum candle that causes a rapid price move.
- Candle Three: Confirms the gap by not overlapping with Candle One’s range.
If the wicks of Candle One and Candle Three do not overlap, a fair value gap exists between them. This unfilled space represents an area where price did not trade efficiently.
Types of Fair Value Gaps
Fair value gaps typically come in two forms:
- Bullish Fair Value Gap: Occurs when strong buying pressure pushes prices upward rapidly, leaving a gap below price action. This signals potential continued upward momentum.
- Bearish Fair Value Gap: Forms during intense selling pressure, creating a gap above price action, signaling potential downward momentum continuation.
Understanding these types helps traders anticipate the probable movement and decide whether to enter long or short positions.
Using Fair Value Gaps for Entry Points
One of the most valuable aspects of fair value gaps is that of their potential as being entry points.
The market often returns again to fill these gaps, as they signal inefficiencies.
Traders act upon this characteristic.
They begin trades once price returns to the gap zone.
There are several common strategies for entry:
- Retracement Entry: Wait for price to pull back to the edge of the gap and enter as it begins to reverse.
- Confirmation Entry: Look for confirmation signals like reversal candlestick patterns or momentum shifts within the gap before entering.
- Aggressive Entry: For experienced traders, placing limit orders directly inside the gap anticipates the filling.
Traders are allowed to enter with tighter stops along with better-defined risk whenever they use fair value gaps as entry points for the reason that the gap boundaries form natural levels regarding support or resistance.
Combining Fair Value Gaps with Other Tools
For stronger trade setups, many traders combine fair value gaps with other smart money concepts such as order blocks or break of structure signals.
Confirming repeatedly institutional interest existing at these levels improves the odds for successful trades.
For example, a fair value gap that is coinciding with an order block creates a more powerful entry point.
Key players have built up positions in this zone making for a particularly effective setup.
This double confirmation guides more clearly with capability to manage risk better.
Timeframe and Reliability
Fair value gaps may be seen from intraday charts to weekly charts on any timeframe.
Gaps that are on higher timeframes such as 4-hour or daily charts are in general more reliable.
They represent stronger institutional activity, and also market imbalances are in fact more meaningful on these timeframes.
For shorter-term trading strategies, smaller timeframes can still be useful, also may produce more false signals.
Risk Management When Trading Fair Value Gaps
While fair value gaps can be powerful tools, risk management is important for people to implement.
Price can shift with unpredictability because of market news or sentiment shifts, plus not every single gap gets fully filled.
Stop-loss orders beyond gap boundaries can manage risk effectively via placement.
Stop-loss orders can also be placed using recent swing highs/lows.
Insights from Tradervue
A respected authority in the trading community stresses that fair value gaps should not be traded alone.
Their perceptions suggest that to identify a gap is only just the first step.
When traders recognize gaps and combine indicators then they succeed through analysis of market context for high-probability trades.
Price reactions refine entry timing more when nearing gap zones.
This also reduces risk.
Learning how to spot and using fair value gaps, mastering fair value gaps can add confidence and precision to your trading toolkit.
These inefficiencies act as useful guides for possible turning points within the market.
They are integrated into a thorough strategy for sound risk management.
