In the today's article, we will discuss an important event in Smart Money Concepts trading - Fair Value Gap (FVG).
You will learn:
What is Fair Value Gap
Why the markets form FVG
How FVG relates to liquidity and SMC
How to apply FVG in trading
Fair Value Gap trading strategy
What is Fair Value Gap?
Fair Value Gap is the specific event when a sudden increase of supply or demand of an asset causes a sharp price movement.
Above, is a great example of a FVG on EURUSD.
Because of the sudden spike of demand, the price bounced rapidly, forming a high momentum bullish candle.
Above, is the perfect example of a Fair Value Gap on USDJPY caused by the sudden excess of supply.
Why It Happens?
There are various reasons why Fair Value Gap occurs.
The most common ones are:
1. The release of some important fundamental news, that immediately change the market sentiment and cause significant buying or selling activity.
2. Activity of Institutional traders, who open / close a trading position of a huge volume.
3. Central bank interventions.
How to Identify Fair Value Gap?
One of the easiest ways to recognize a Fair Value Gap is to learn a simple candlestick pattern.
This candlestick pattern consists of 3 consequent candlesticks. The pattern can be bullish or bearish.
Bullish FVG
Bullish pattern will signify the excess of demand.
It will be based on a bullish or bearish candle, followed by a relatively strong bullish candle, followed by a bullish or bearish candle.
The level of the HIGH of the first candle should be LOWER than the level of the LOW of the third candle.
The space between these levels is a Fair Value Gap.
Above is the example of a FVG on USDCAD.
I underlined the high of the first candle, the low of the third candle and the Fair Value Gap between them.
But it does not mean that every Bullish FVG will give an accurate signal. Keep reading, and I will explain the situation when FVG doesn't work. But first, let's discuss Bearish FVG.
Bearish FVG
Bearish pattern will signify the excess of supply.
It will be based on a bullish or bearish candle, followed by a relatively strong bearish candle, followed by a bullish or bearish candle.
The level of the low of the first candle should be higher than the level of the high of the third candle.
The space between these levels is a Fair Value Gap.
Above is the example of a FVG on Gold.
I underlined the low of the first candle, the high of the third candle and the Fair Value Gap between them.
As you noticed, in both examples, the second candle in the pattern is a strong candle with a big body. It is the main element of the pattern and a formation of such a candle will help you to easily find Fair Value Gap.
What Fair Value Gap means?
Fair Value Gap signifies a highly probable shift in the market sentiment.
A bullish FVG implies the dominance of the buyers on the market and a bullish continuation.
Take a look, how a formation of a Bullish Fair Value Gap triggered a strong bullish wave on GBPAUD.
While a bearish FVG implies the dominance of the sellers on the market and a bearish continuation.
Above is how a formation of a bearish FVG made the market reverse rapidly.
When Fair Value Gap Doesn't Work?
Always remember that the formation of a Fair Value Gap alone, most of the time, will give a very poor signal.
The FVG that is formed beyond the liquidity zones can easily be the manipulation.
You can see that even though GBPJPY formed a clear Bearish Fair Value Gap, the price resumed growth after its formation.
In this case, FVG was just a manipulation.
These manipulations occur because the market liquidity is relatively low beyond the liquidity zones. For that reason, the market participants may manipulate that even with small trading volumes, making the price form the false fair value gaps.
Liquidity is the KEY!
When you spotted a Fair Value Gap, make sure that it is formed within a liquidity zone.
The liquidity zone below current price levels will be called a demand zone, while a liquidity zone that is above current price levels will be called a supply zone.
The formation of a bullish Fair Value Gap within a demand zone will give a very strong bullish signal. With a high probability, the price will go up then.
Above you can see a solid demand zone that EURAUD reached.
After its test, a bullish FVG was formed.
Its formation triggered a strong bullish continuation.
The formation of a bearish Fair Value Gap within a supply zone will give a very strong bearish signal. With a high probability, the price will go down then.
Above is the example of a bearish FVG that formed after a test of a supply zone on EURGBP.
A bearish movement followed then.
How to Trade?
There are various strategies to trade FVG.
One of the simplest ones is to open a trading position immediately after a confirmed formation of a FVG.
But, this method does not provide a good reward to risk ration.
Remember, that after a formation of a Fair Value Gap with a high probability, the market will fill that.
You can see that after a formation of a Bullish FVG, USDCAD formed a strong bearish candle and filled the gap.
After the gap, gets filled, the market tends to start moving in the desired direction.
For that reason, your best area to buy the market from after a formation of a bullish FVG is Fair Value Gap itself.
Set your buy limit order within.
Stop loss will lie below the demand zone.
And take profit will be based on the closest supply zone.
And a nice profit was made!
Below, you can see a bearish FVG after a test of a supply zone on CADCHF.
Sell limit is lying within the FVG, stop loss is above the supply zone, take profit is the closest demand zone.
After a Fair Value Gap was filled, the price dropped to the target.
Fair Value Gap is one of the most significant events in Smart Money Concepts trading, its recognition will help you to accurately predict the coming bullish and bearish waves, and trade them safely!
I hope that this FVG strategy will help you to make a lot of pips! Good luck!
