Tips and Techniques for Trading Fair Value Gaps Successfully

In trading and technical analysis, fair value gaps (FVGs) are crucial in understanding market behavior and making informed trading decisions. 

This article aims to demystify fair value gaps, explain their significance, and provide a comprehensive guide on identifying and trading them effectively.

What Are Fair Value Gaps?

A fair value gap is a price range on a chart without trading activity and you must have a  Instant Funding Prop Firm for trading. 

This gap is typically created between three consecutive candles (or bars) on a price chart. 

Understanding this concept requires analyzing the highs and lows of these candles. 

Identifying Fair Value Gaps

1. Bullish Fair Value Gaps: These occur when there is a gap between the low of the first candle and the high of the third candle in a bullish trend.
2. Bearish Fair Value Gaps: These are identified when there is a gap between the high of the first candle and the low of the third candle in a bearish trend.

For example, if the first candle's high and the third candle's low do not overlap, the gap between them is considered a fair value gap.

Why Do Fair Value Gaps Matter?

Fair value gaps are significant because they indicate areas of price imbalance where the market may return to "fill" these gaps. 

This can provide traders with potential entry and exit points.

Analyzing Fair Value Gaps

1. Consecutive Enrichment: This refers to the strength of a fair value gap. If the market dips into the gap but closes above it, it indicates a bullish, solid fair value gap.
2. Consequential Encroachment (CE): The midpoint of a fair value gap. If the market dips into the gap but closes above the CE, the gap is considered solid and valid.

Trading Fair Value Gaps

Entry Points

• Identify a fair value gap.
• Wait for the market to return to the gap.
• Consider entering a long position if the market closes above the CE in a bullish gap.
• If the market closes below the CE, consider entering a short position for bearish gaps.

Stop Loss Placement

• Place the stop loss below the CE for bullish gaps.
• Place the stop loss above the CE for bearish gaps.

Examples of Fair Value Gaps

Bullish Example

Consider a scenario with three bullish candles:

• The first candle's low is $100.
• The third candle's high is $110.
• If there is no overlap between these prices, the gap between $100 and $110 is a bullish fair value gap.

Bearish Example

For three bearish candles:

• The first candle's high is $120.
• The third candle's low is $115.
• The gap between $120 and $115 is a bearish fair value gap if there is no overlap.

Advanced Concepts in Fair Value Gaps

1. Fair Value Gap Fill: When the market moves back into the fair value gap and closes the gap.
2. Inverse Fair Value Gap: When the market reacts to a fair value gap in the opposite direction, often used by experienced traders.
3. Volume Gaps: Similar to fair value gaps, they occur due to significant volume changes.

Practical Application: Real Market Examples

Example 1: GBP/USD

• On a 1-hour chart, identify a fair value gap between the first candle's low and the third candle's high.
• Observe if the market retraces to fill the gap and reacts accordingly.

Example 2: USD/JPY

• On a 4-hour chart, notice a fair value gap and track the market's reaction when it returns to this gap.

Emotional Control and Fair Value Gaps

Trading fair value gaps requires emotional discipline. 

Read Here: How I Doubled My Account in Crypto Swing Trading in 2024

Many traders fail not because of poor analysis but due to emotional reactions. Practice trading with small positions to build emotional resilience.

Conclusion

Fair value gaps are powerful for traders, providing insights into potential market reversals and continuation patterns. 

Identifying and trading these gaps can enhance your trading strategy and increase your profitability. Remember to practice proper risk management and remain disciplined in your trading approach.