Trading Fair Value Gaps
If you consider yourself to be an active trader but don’t know what fair value gaps are, I truly believe this lesson could be a key pivot toward your success as a trader.
Fair value gaps represent inefficiencies and imbalances in the price of an asset. In other words, they mark “imbalance” zones where buying and selling are not equal. Institutions (smart money) tend to set large buy or sell orders in these gaps that can fuel large movements in favorable directions for retail traders. You always want to be on the side of smart money and trading fair value gaps is a good way to do that.
Fair Value Gaps are created within a three-candle sequence and are commonly visualized on the chart as a large candle whose neighboring candles’ upper and lower wicks do not fully overlap the large candle. Sound confusing? Don’t worry, we’ll simplify it.
(Fair Value Gap Formation)
When scanning for fair value gaps, look for 3 candles with the middle one showing a large gap up or down in price. Then simply draw a box between the wicks of the first and last candles. Voila, you have found a fair value gap.
Fair value gaps can be formed from both bearish and bullish formations.
(All examples of fair value gaps)
Trading fair value gaps aren’t difficult, but there are different ways to trade them depending on your risk tolerance. After price forms a fair value gap, it usually returns but then bounces in the opposite direction making lower lows or higher highs. Some traders wait for the gap to fill, others wait for the midpoint of the zone, and the rest trade at the first break.
(Bullish fair value gap)
The outcome of multiple different entry points can be seen in the image above.
(Bearish fair value gap)
The same rules and conditions apply for going short in trades.
I plan a lot of my trades around fair value gaps. I look for positive or negative sentiment under a company and use these gaps to find my entry points. Hopefully, you were able to gain value and learn a lot from this lesson. For more posts like this, news updates, and stock alerts, consider subscribing to our newsletter for free.
Happy Trading
-The Wolf