Understanding the Fair Value Gap (FVG)

The fair value gap (FVG) is a price action element formed by a three-candle sequence. It represents an impulsive price reaction to zones of liquidity or inefficiency, typically caused by a surge of high volume into the market. This leads to an uneven exchange of assets between buyers and sellers.

Formation of an FVG

  • Bullish FVG: Formed when the high of the first candle does not overlap with the low of the third candle. This indicates a lack of selling volume to absorb the buying pressure, resulting in unfilled buy orders.
  • Bearish FVG: Formed when the low of the first candle does not overlap with the high of the third candle. This indicates insufficient buying volume to absorb the selling pressure, leading to unfilled sell orders.

When the highs and lows of the candles overlap, the exchange is considered efficient, which is why the term fair value is used to describe balanced price action.

Key Levels and Price Reaction

An FVG consists of upper and lower boundaries, but traders also pay close attention to the 0.5 level (midpoint). This level is considered a strong area where the price is expected to bounce, making it a viable entry point for positions.

Validity and Invalidation

The validity of an FVG during a test depends on market context and timing. However, the general rules for maintaining a valid zone are:

  • Bullish FVG: The price should not close below the lower boundary.
  • Bearish FVG: The price should not close above the upper boundary.

If the price closes beyond these boundaries, it is considered an inverted fair value gap, which may indicate a continuation of the movement in that new direction.

Real Chart Examples

In practice, FVG zones often appear after a liquidity raid followed by aggressive volume. For example:

  1. Liquidity Raid and Rejection: Price may perform a liquidity raid and then enter a zone. It might test an initial FVG without enough volume to move, then drop to a second, lower FVG zone where a rejection block forms, allowing the trend to continue.
  2. Timeframe Analysis: On a one-day timeframe, multiple FVG zones can form in succession. If the price consistently fails to close above (in a bearish trend) or below (in a bullish trend) these zones, it confirms the FVG has enough strength to cause a reversal.

Detailed Summary

The text explains the Fair Value Gap (FVG), a three-candle price action pattern that identifies market inefficiencies and liquidity imbalances. These gaps occur when high volume causes an impulsive move, leaving unfilled orders in its wake. Traders utilize these zones—particularly the 0.5 midpoint—to find entry points and determine trend strength. An FVG remains valid as long as the price does not close past its boundaries; otherwise, it becomes an inverted fair value gap, signaling a potential trend continuation.

Key Takeaways

  • An FVG is a three-candle sequence representing an uneven exchange between buyers and sellers.
  • A Bullish FVG forms when the high of the first candle and the low of the third do not overlap; a Bearish FVG occurs when the low of the first and high of the third do not overlap.
  • The 0.5 level (midpoint) is a critical area within the gap where price is expected to react or bounce.
  • Validity is maintained if a bullish FVG holds above its lower boundary or a bearish FVG holds below its upper boundary.
  • If the price closes beyond the FVG boundaries, it is classified as an inverted fair value gap, suggesting price movement will continue in that direction.
  • FVGs often emerge following liquidity raids and serve as indicators of trend strength across various timeframes.