The term "Fair Value" is dangerously ambiguous. For a value investor, it is an abstract calculation of a company's worth. For a price action trader, it means something entirely different and infinitely more practical. We are not discussing fundamentals. We are discussing structure.
The Fair Value Gap (FVG)—also known as a market imbalance or liquidity void—is a specific, three-candle pattern that reveals a structural weakness in price delivery. It is a wound in the market's fabric, an area where price moved with such violent, one-sided force that it failed to be traded efficiently.
Understanding and identifying these voids is not a trading "trick." It is a lesson in reading the market's raw mechanics.
What is a Fair Value Gap (Technically)?
An FVG is not a subjective feeling. It is a precise, visual pattern formed by three consecutive candlesticks.
- Candle 1: The initial candle. Note its high and low.
- Candle 2: The impulsive candle. This candle moves aggressively in one direction, leaving the gap.
- Candle 3: The confirming candle.
A Bullish FVG is formed when the low of Candle 3 does not overlap with the high of Candle 1. The empty space between these two points is the Fair Value Gap.
A Bearish FVG is formed when the high of Candle 3 does not overlap with the low of Candle 1. The space between them is the gap.
This is not an indicator. It is a footprint left behind by large, urgent orders overwhelming the opposite side of the market.
The Metaphysics of the Void: Why FVGs Form and Fill
The market abhors a vacuum. An FVG represents a vacuum of liquidity. When price rockets upward, it leaves behind a trail of unfilled buy orders and untested price levels. The market's algorithm—the collective mechanism of all its participants—has a memory. It knows this area was delivered inefficiently.
Price is often drawn back into these voids for two primary reasons:
- Rebalancing: The market seeks equilibrium. It must return to the inefficiently priced area to "re-price" it, allowing participants who missed the initial move a chance to engage. This process fills the liquidity vacuum.
- Targeting Liquidity: Sophisticated algorithms know that retail traders place stop-losses within or on the other side of these gaps. The FVG becomes a magnet for price, not just to rebalance, but to hunt the liquidity resting there.
An FVG is a sign of weakness. It is a structural flaw that the market will likely seek to repair.
Trading the Imbalance: Two Models of Execution
Identifying an FVG is useless without a strategy to engage with it. There are two primary models.
Model 1: The Reversion Model (Filling the Gap)
This is the most common approach. The thesis is that price will revert to fill the inefficiency.
- Entry: A trader waits for price to re-enter the FVG. An entry can be placed at the edge of the gap or, more conservatively, at the 50% level of the gap (known as the "consequent encroachment").
- Stop-Loss: Placed just beyond the FVG, on the other side of the impulsive candle (Candle 2).
- Target: The initial target is often the other side of the gap, with further targets based on broader market structure.
Model 2: The Rejection Model (The Gap as Support/Resistance)
In a very strong trend, the market may only partially fill the gap before continuing its original move. The FVG acts as a high-powered support or resistance zone.
- Entry: A trader waits for price to touch the edge of the FVG and show a strong reaction (e.g., a rejection wick or an engulfing candle in the direction of the trend).
- Stop-Loss: Placed inside or just beyond the FVG.
- Target: A new high (in an uptrend) or a new low (in a downtrend).
The Dangers of the Void: Common Traps and Misinterpretations
An FVG is not an infallible signal. Context is paramount.
- Timeframe is Key: An FVG on a 1-minute chart is noise. An FVG on a Daily or 4-Hour chart is a significant structural event that can dictate price action for days or weeks. Always prioritize higher timeframe gaps.
- Not All Gaps Are Equal: An FVG that forms in alignment with the prevailing trend is far more reliable than one that forms against it.
- The Run-Through: Sometimes, price will slice straight through an FVG without slowing down. This is often a sign of overwhelming momentum and signals that the underlying trend is even stronger than anticipated. The FVG has failed as a point of interest.
Conclusion: Reading the Scars of the Market
Stop looking for magic formulas. The Fair Value Gap is not a guarantee of profit; it is a tool for seeing the market with greater clarity. It reveals the narrative of price—where it moved with conviction and where it left behind vulnerabilities.
By learning to identify these structural voids, you move beyond simply reacting to price and begin to anticipate its next move based on its inherent need to seek balance and liquidity. Observe them on your charts. Note how price interacts with them. This is the path to moving from a pattern-follower to a true market analyst.