SMC Basics: Fair Value Gap (FVG)

In the world of financial markets, where every choice can make you earn or lose
money, having an advantage is very important. Think about having the ability to
easily find good chances to earn money that others might not see, while making your
strategy simpler

This is what the Fair Value Gap trading strategy does. This strategy, used mostly by
traders who look at price changes, is very easy but very strong

FVGs happen when the force of buying or selling causes big changes in prices, which
results in gaps appearing on the price charts. These gaps can be spotted by doing a
technical analysis that includes studying patterns in price charts and candlestick
patterns. Traders can classify FVGs into two kinds: Undervalued FVGs, where the
prices are less than what they should be, and Overrated FVGs, where the prices are
more than their actual worth

What is the Fair Value Gap

The idea of a fair value gap is known by different names among traders who focus
on price changes. Some call it an imbalance, inefficiency, or a liquidity void. But what
are these imbalances? They happen when the forces of buying and selling apply a lot
of pressure, causing big and quick changes in price. These changes, whether they
make prices go up (bullish) or down (bearish), create gaps in the market. These gaps
are the main focus of the FVG strategy

The idea behind FVGs is based on the belief that the market naturally tries to correct
itself. These differences in price or inefficiencies can’t last for a long time, and the
market tends to move back towards them before continuing in the same direction as
the first big move

Why are FVGs important for traders who focus on price changes? They give a special
benefit by showing where to start and end trades in the market. Like many other
kinds of price gaps, these FVG imbalances serve as signs on the chart, helping
traders know when to start and end a trade. But, the fair value gap is different from
other price gaps

Unlike other gaps where there’s no trading happening on a price chart, the FVG is
formed by a pattern of three candlesticks that causes an imbalance in the market’s
price changes. When this big change happens suddenly, either going up or down, it
leaves a gap between the first candle’s wick and the last candle’s wick; this is the
FVG

The gap in the chart above represents an opportunity - a possible return to

equilibrium. In this case, we can see a three-candle formation that indicates a drop in
price where the lowest price of the first and the highest price of the third candle
create a theoretical gap. Typically, after this formation, the markets tend to form a U
shape and go back to fill this gap.

It’s at this point where there are no trades happening that traders can make informed
decisions, using the advantage of FVGs to benefit from market adjustments and earn
from the reorganization
 How to Identify a Fair Value Gap on a Price Chart

Like most patterns on a chart, the hardest part of the fair value gap strategy is
spotting this special formation on a price chart. For FVGs, a pattern of three candles
must show up with certain rules. When this happens, the space or gap between the
wicks of the first and third candles is the fair value gap

1. Finding the Big Candlestick: The first step in spotting a Fair Value Gap is to search
for a big candlestick on your price chart. This candlestick should have a large
body-to-wick ratio, ideally around 70%.

2. Checking Neighboring Candlesticks: After you've found the big candlestick, check
the ones right before and after it. These neighboring candlesticks should not
completely overlap the big one. Instead, small overlaps might happen on the top and
bottom sides of the big candlestick. Then, it's the gap between the wicks of
neighboring candlesticks that forms the fair value gap.

3. Outlining the Fair Value Gap: Lastly, you need to outline the fair value gap and draw
it on your price chart. In a downward trend, the Fair Value Gap is the price area
between the previous candlestick’s low and the following candlestick’s high. This is
where the imbalance in the market becomes clear, indicating a possible trading
chance. The same applies to an upward trend but with the opposite conditions.
In the EUR/GBP 15-Min chart below, you can see what the fair value gap candlestick
pattern looks like on a price chart. Once you notice a big candlestick with a small
candle prior to it and another small candle that appears after the big candlestick, you
can search for the fair value gap entry level

Here are some more examples of FVG on the charts: