Fair Value Gap (FVG)

How a Fair Value Gap Works Under the Hood

In healthy financial markets, every price level sees two way trading between buyers and sellers. When an institutional participant enters a massive market order, price moves violently in one direction within a single candle, leaving an unfilled price inefficiency.

The Three Candle Formation

1. Candle 1: The base setup candle before the aggressive move.
2. Candle 2: A massive expansion candle moving rapidly upward or downward with heavy volume.
3. Candle 3: The subsequent candle whose wick fails to overlap with the wick of Candle 1.

The empty price zone between the high of Candle 1 and the low of Candle 3 (in a bullish move) is the Fair Value Gap.

Why Smart Money Returns to Fill FVGs

Financial algorithms and institutional market makers are designed to deliver balanced price action. When an imbalance exists, resting limit orders remain unfilled within that zone.

1. Rebalancing Liquidity: Price acts like a vacuum, pulling back into the gap to fill resting orders left behind by the initial impulse.
2. High Probability Entry Zones: Traders look for price to tap into the 50 percent level of the gap (the Consequent Encroachment) to find continuation entries aligned with the dominant trend.

Common Mistakes to Avoid When Trading FVGs

1. Trading Every Gap: In strong trending markets, not every gap gets filled immediately. Always trade gaps that align with higher timeframe market structure.
2. Ignoring Higher Timeframes: An FVG on a 5 minute chart has very little significance if it runs directly into a major 4 hour resistance level.
3. Entering Without Confirmation: Never enter blindly just because price touches a gap. Wait for lower timeframe rejection or market structure shifts.

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