Fair Value Gaps (FVGs), also known as Imbalances, are key concepts in Smart Money trading. They refer to areas on a price chart with a significant difference between buying and selling activity. These gaps or imbalances are created when the market moves too quickly, leaving a lack of trading activity in specific price ranges. Understanding and identifying these gaps is crucial for traders looking to align with institutional trading strategies, ensuring they are in sync with the market.
Key Characteristics of FVG/Imbalances:
- Creation of Fair Value Gaps:
- Fair Value Gaps occur during strong price movements, such as a large bullish or bearish candle, where there is little to no overlap between the candles. This creates a gap between the high of one candle and the low of another (in a bullish scenario) or the low of one candle and the high of another (in a bearish scenario).
- FVG/Imbalance in Price Action:
- An FVG/Imbalance reflects a disparity between buying and selling pressures. For example, in a strong upward move, buying pressure overwhelms selling pressure, causing the price to shoot up and leave behind an area with little to no trading. This area is the imbalance.
- Market Tendency to Fill Gaps:
- Markets often seek to “fill” these gaps or imbalances, as price tends to return to these levels to correct the imbalance. This behaviour is rooted in the market’s tendency to revert to fair value, where buying and selling pressures are more balanced.
- Significance in Trading:
- FVGs/Imbalances are significant because they often act as magnets for price. Traders can use these levels to anticipate potential price reversals or retracements as the market seeks to fill these gaps.
- Institutional Activity:
- FVGs are often associated with institutional trading. When large institutions place massive orders, the market may move quickly, leaving behind these imbalances. Smart money traders look for these gaps as clues to where institutions have been active.
How to Identify and Trade FVG/Imbalances:
- Identification:
- Look for significant, impulsive moves in the market with a noticeable gap between the wicks of consecutive candles. In a bullish scenario, an FVG is identified between the high of the first candle and the low of the second candle if there is no overlap. In a bearish scenario, it’s between the first candle’s low and the second candle’s high.
- Confirmation:
- Once identified, monitor how the price interacts with the FVG. The market may retrace to this area to “fill” the gap, allowing traders to enter trades in line with the more significant trend.
- Entry Points:
- Traders often look to enter trades when the price retraces into the FVG. For example, if there’s a bullish FVG, traders might look to enter a long position when the price dips into this gap, anticipating a move higher as the gap is filled.
- Stop-Loss and Targets:
- A stop-loss can be placed beyond the FVG to protect against a deeper retracement. Profit targets can be set based on key support or resistance levels.
Example:
- Bullish Fair Value Gap:
- Suppose the market has a strong upward movement, resulting in a large bullish candle. The previous candle’s high is significantly lower than the low of the following candle, creating a gap. This area, where no trading occurred, is the FVG. Traders might expect the price to retrace into this gap before continuing higher eventually.
- Bearish Fair Value Gap:
- In a strong downward move, a bearish candle might create an FVG if its low is much higher than the high of the following candle. This gap acts as a resistance level, where traders anticipate the price retrace before resuming the downtrend.
Fair Value Gaps (FVGs) or Imbalances are crucial concepts in Smart Money trading. They represent areas on the chart where the market moved too quickly, leaving gaps in price action due to imbalanced buying or selling pressure. These gaps often act as magnets for price, with the market tending to return to these levels to “fill” the gaps. Understanding and utilizing FVGs can help traders align with institutional trading strategies and improve their trading decisions.
Tags: Fair Value Gap, Imbalance