FxNews—Price action and technical traders love to fiddle with the price chart and analyze it from multiple aspects. One of the least appreciated strategies is FVG, or trading the Fair Value Gaps.
The FVG trading strategy is categorized as a price pattern. If you like technical and price action analysis, this article is for you.
What is a Fair Value Gap?
A Fair Value Gap (FVG) in forex is an area on a price chart where a trading security’s price quickly moves up or down, skipping over some price levels without trading. It’s like a jump in the price where no trading occurred, leaving a blank space or ‘gap’ on the chart.
Furthermore, FVGs, or Fair Value Gaps, are noticeable on trading charts as large candlesticks that do not overlap entirely with the wicks of the neighboring candlesticks.
This pattern consists of three specific candlesticks. Depending on the market movement, these FVGs can be classified as bullish, indicating a potential price increase, or bearish, suggesting a price decrease.
Essentially, an FVG signals a price gap that wasn’t filled immediately, making it a point of interest for traders looking for market trends. This indicates that the Fair Value Gap often attracts the price towards it, much like a magnet.
Fair Value Gaps are unique circumstances in the financial market where the prices range from what they genuinely value. This divergence from the actual value creates an opportunity for traders. Typically, market prices revert to their true or fair value over time.
Understanding this pattern can help traders make informed decisions by anticipating potential price corrections. This strategy can be particularly useful in spotting good trading opportunities when the market adjusts itself to reflect the true value of assets.
When and Why Do Fair Value Gaps Form?
Market prices occasionally differ from expectations, leading to a Fair Value Gap. In this section, we’ll outline the conditions that often cause such gaps to form.
High-impact news events that unexpectedly shift the mood in financial markets often lead to what is known as a Fair Value Gap (FVG). One common trigger for this is a sudden hike in interest rates. When rates increase without prior warning, the value of the domestic currency usually jumps, resulting in an FVG.
This sensation isn’t limited to economic indicators; it contains many events. Political news, such as unexpected election results or the outbreak of conflicts, can also drive market volatility. Natural disasters like earthquakes or severe weather conditions can significantly disrupt markets.
Bullish Fair Value Gap (FVG)
The image below demonstrates a bullish Fair Value Gap when there is a gap between the first candle’s high and the third candle’s low.
A bullish Fair Value Gap (FVG), also known as a bullish gap, represents a scenario in the financial markets where there is a noticeable leap in the price of an asset upwards, with no trading happening in the gap itself. This situation typically arises when an overwhelming amount of buying pressure pushes the price to skip over a range of values, effectively creating a visible separation on the price chart.
The USD/JPY 4-hour price chart below illustrates the Bullish Fair Value Gaps, highlighting where the uptrend resumed each time the FVG signaled a buy.
In technical analysis, a bullish FVG is regarded as a bullish signal, suggesting that the market sentiment is strongly positive and may lead to further price increases. It also acts as a psychological marker on the chart, forming a support zone.
Traders often watch these gaps closely for signs that the price might return to this zone, known as ‘filling the gap.’ However, if the price does not return and instead continues upward, it reinforces the strength of the bullish trend.
Fair Value Gaps, or FVG, are often triggered by unexpectedly positive news, such as stellar earnings reports, favorable economic data, or other events that significantly boost investor confidence in the asset. The gap indicates a strong demand as investors are willing to buy at higher prices, showing confidence that the asset will continue to appreciate.
Bearish Fair Value Gap (FVG)
A bearish Fair Value Gap (FVG), also known as a bearish gap, occurs in trading charts when the price of an asset sharply declines, resulting in a noticeable gap on the chart. This type of gap emerges when the level of selling pressure is so high that it causes the asset’s price to jump downward across a range of prices, avoiding any trades within that range.
The image below demonstrates a Bearish Fair Value Gap when there is a gap between the first candle’s low and the third candle’s high.
The 4-hour chart below showcases the GBP/USD currency pair with the Fair Value Gap indicator. As shown, the downtrend resumed each time the FVG indicator identified a gap. Occasionally, the price returned to fill the gap area, which acted as strong resistance, leading to the continuation of the bearish market.
Negative catalysts often shower price charts with bearish Fair Value Gaps (FVG). This could be the release of poor earnings reports, unfavorable economic data, changes in regulatory landscapes, or geopolitical tensions that negatively impact investor sentiment and market stability.
From a technical analysis perspective, bearish FVGs are critical to understanding because they often act as areas of resistance when the price attempts to recover. If prices rise back to the level of the gap, this area can act as a ceiling, resisting upward movements and potentially confirming the strength of the ongoing downward trend.
Moreover, bearish FVGs serve as important psychological markers on price charts, symbolizing moments of strong market aversion to asset prices at certain levels. If the market does not ‘fill’ the gap—meaning the price does not return to trade in the gapped area—it often signifies that the market supports the lower price levels, reinforcing the bearish sentiment.