Traders in the financial market are always looking for strategies that provide them an edge in the market. The Fair Value Gap is a very powerful tool that has emerged over the past few years. Fair Value Gap offers traders to support market inefficiencies so that they can make good profits and take good trades. But what is actually the fair value gap and how can you identify it and very importantly how can you make money from it. In this article, I will tell you how you can use the fvg in trading to get a good profit.
What is a fvg in trading?
The fair value gap refers to the price gap that occurs when the market experiences very rapid price movements, which is short-term imbalance between buyers and sellers.
Normally, markets are efficient when buyers and sellers orders are matched evenly. However, during periods of very high volatility such as economic announcements or unexpected news that move prices quickly and leave gaps behind. These gaps are known as Fair Value Gaps and are potential indicators of areas where the market may retrace to restore efficiency.
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Key Features of FVGs:
Market Inefficiency:
In trading, FVGs form as a result of short-term supply and demand imbalances;
-Price Gaps:
FVGs are seen on charts as areas where price moves swiftly, leaving gaps in the candlesticks;
Potential Retracements:
These gaps often attract price retracements, offering “trading opportunities” for profit.
Simply put, “Fair Value Gaps” represent zones of inefficiency in the market. Traders often expect prices to revisit these zones, which provides opportunities to profit from “market corrections” or “trend continuations”.
How do “fvg in trading” Form?
Understanding how “Fair Value Gaps” form is essential to spotting them on the chart. FVGs usually form in response to strong, directional price movements caused by overwhelming buyer or seller momentum. Let’s explore how they are created:
1. Aggressive Buying or Selling
When the market moves very quickly towards buying or selling, the market shows a very sharp price move in one direction. This quick change in price leaves behind a gap.
2. Inefficient Market Action
During these aggressive moves, the market does not allow for the orderly matching of buy and sell orders and creates inefficiencies. Resulting in gaps between the high and low of the first candle and the open and close of the next candle.
3. Gap-Filling
When price returns to its efficiency, it often retraces to fill the gaps, so this gap-filling behaviour provides traders with an excellent opportunity to predict the future price.
For example, in an upward price movement:
- – Candle 1 closes at $100;
- – Candle 2 opens at $105 and closes at $110;
- – Candle 3 opens at $115.
The gap between $105 and $110 forms a “Fair Value Gap”, as the price skipped over this range without significant trading activity.
Types of fvgs in trading
Fair value gaps are formed in both bullish and bearish market, depends on the direction of the price movement. Fair value gaps are classified into two types.
1. Bullish Fair Value Gap
“Bullish value gaps” form when price moves sharply in an upward direction and creates a gap. These gaps often indicate that the buyers outbid sellers, it creates a “potential zone” where prices might return before moving into their upward trajectory.
2. Bearish Fair Value Gap
“Bearish fair value gaps” occur when price moves downward too quickly and creates a gap. These gaps indicate that “sellers have dominated the market” and price may now retrace into these gaps before resuming the downward trend.
In both cases, traders use “fair value gaps” to find “potential trading opportunities”, whether they expect the price to come up to fill a gap or continue in the current direction.
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How to Identify Fair Value Gaps on Charts
To identify fair value gaps on price charts, you first need to understand price action and candlestick patterns. Here, I will tell you step by step how you can spot Fair Value gaps.
Step 1: Analyse Market Conditions
First, start by analysing the market to see where strong directional price moves have occurred. Fair value ups are often created when high-volatility momentum shifts occur, such as major economic news or announcements.
Step 2: Look for Gaps
Analyse the price chart and find gaps between High and low in first candle and open or close in the second candle. When the gap occurs, it indicates a fair value gap.
Step 3: Mark the Gap Zone
Once you have identified the FVG on your price chart, mark the gap zone on the price chart. This zone indicates that the market has moved very quickly and has not left any trading activity behind.
Step 4: Monitor Price Action
Once you have marked the up-fair value gap on the price chart, carefully monitor the price action to see that when it reaches the gap, the price often returns to its zone and creates a chance for you to take that profitable trade.
How to Earn from Fair Value Gaps
Now that you know what fair value gaps are and how you can identify them on the price chart. There are so many opportunities to trade FVG and it depends on your style. Here are three most important strategies that I will tell you to make a lot of money.
1. Gap-Fill Strategy
A very popular way to make money from the fair value gap is when the price moves back to fill its gaps. Since the market returns to fill its inefficiency areas, traders expect to take positions as the price retraces back into the fair value gap zones.
How to execute a gap-fill trade:
– Identify the Gap:
Spot a recently formed Fair Value Gap on the chart;
-Set Your Entry Point:
Enter the trade when the price begins to move back toward the gap;
– Take Profit in the Gap Zone:
Place your profit target within the gap to capitalize on the retracement.
2. Trend Continuation Strategy
Fair Value Gaps can also be used to signal a trend continuation.
How to execute a trend continuation trade:
– Identify the FVG:
Look for a Fair Value Gap within a well-defined trend;
– Wait for the Retracement:
Allow the price to retrace partially or fully into the gap zone;
– Enter the Trade:
Once the retracement occurs, place your trade in the direction of the prevailing trend.
3. Stop-Loss Placement
Fair Value Gaps are also useful for stop-loss placement. When trading in volatile markets, placing stop losses beyond the FVG zone can help protect trades from being prematurely closed out. Prices often retrace to these gaps before resuming their trend, making them safer areas for stop-loss placement.
How to place an FVG-based stop-loss:
- – Mark the FVG on your chart;
- – Set your stop loss just beyond the gap:
This helps avoid being stopped out during a retracement while keeping your trade open for potential gains.
Managing Risk When Using fvgs in Trading
It is very crucial to manage your risk whenever you are trading FVGs. Markets are not always predictable, in order to be profitable it is very essential to have proper risk management plan.
Here are a few risk management tips when trading Fair Value Gaps:
– Use Stop-Loss Orders:
Always place stop-loss orders to limit your risk;
– Trade Smaller Positions:
Avoid over-leveraging by trading smaller position sizes, especially in volatile conditions;
– Analyse the Broader Market:
Consider the overall market trend, support, and resistance levels before entering a gap trade.
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