A Fair Value Gap represents a gap or imbalance in price action, where a price movement lacks sufficient market participation on one side—buy or sell—leading to an uneven flow of orders. This imbalance typically occurs when a strong bullish or bearish move occurs in a short amount of time, leaving behind a price area that was inadequately traded.
In practical terms, it happens when:
- The market moves too quickly, leaving unfilled orders behind.
- There is a rapid price change, leaving a section of the price chart where there is minimal to no trading activity.
For instance, in a bullish scenario:
- The price might gap up, leaving a void between the low of the first bullish candle and the high of the next one.
- This gap can represent an area where buy-side liquidity was too strong, and sellers were unable to adequately participate.
Smart money traders, including those who follow Ghosttraders’ strategies, pay special attention to these Fair Value Gaps because price often retraces to fill in these gaps, creating trade opportunities.
How Do Fair Value Gaps Relate to Liquidity?
Fair Value Gaps are intrinsically tied to the idea of liquidity. In the financial markets, liquidity refers to how easily an asset can be bought or sold without causing a significant price shift. When there is low liquidity, price moves tend to be erratic, creating gaps or voids on the price chart. Conversely, high liquidity allows for smoother price action.
Here’s how FVGs relate to liquidity:
- Price Imbalance: A Fair Value Gap occurs when there is a price imbalance caused by a lack of market participants on one side of the market (buy or sell). This imbalance often forms liquidity voids, which smart money eventually exploits.
- Filling the Gap: After the gap occurs, the market tends to retrace to fill the Fair Value Gap. This happens because institutions—often responsible for causing the gap—later return to the area to fulfill unexecuted orders. This process is tied to liquidity, as price needs to revisit these zones to find resting orders and ensure equilibrium.
Fair Value Gaps vs. Liquidity Voids
While both Fair Value Gaps and Liquidity Voids represent gaps in price action, they differ in their cause and significance within smart money trading strategies. Here’s a comparison between the two:
| Aspect | Fair Value Gaps (FVG) | Liquidity Voids |
|---|---|---|
| Definition | Gaps between consecutive candles where little to no trading occurred | Areas on the chart where price has moved too quickly, leaving behind a “void” in market participation |
| Cause | Created by a strong, rapid move, usually due to institutional buying/selling | Caused by a lack of market participants on one side, resulting in large price swings |
| Market Behavior | Price often retraces to fill the gap as smart money seeks to balance the market | Price may revisit these voids to “fill” them before resuming its trend |
| Importance in Trading | FVGs are key areas where price is likely to retrace, offering entry opportunities | Liquidity voids indicate imbalances that smart money may exploit in the future |
| Typical Scenario | Gaps seen during high volatility or after major news releases or institutional moves | Voids appear after strong directional moves that leave gaps in liquidity |
How to Trade Using Fair Value Gaps
Fair Value Gaps provide traders with an edge in identifying key retracement levels and understanding smart money behavior. Here’s a step-by-step guide on how to trade effectively using FVGs:
1. Identify the Fair Value Gap
The first step is to spot the Fair Value Gap on the chart. This typically occurs after a strong price move, either bullish or bearish, where price has skipped over certain levels. Look for gaps between consecutive candles where price did not fully overlap, indicating a lack of trading in that range.
For example:
- In a bullish scenario, look for a gap between the low of a candle and the high of the next candle.
- In a bearish scenario, look for a gap between the high of one candle and the low of the next candle.
2. Wait for Price to Retrace
Once you’ve identified the FVG, wait for the price to return to fill the gap. This retracement often presents an opportunity to enter the market in line with the overall trend.
3. Confirm with Volume or Order Flow
It’s important to confirm the validity of the FVG by looking at volume or order flow. A Fair Value Gap with low participation on the opposing side is a strong sign that the price will likely retrace to fill that gap. Additionally, liquidity voids created during this process can serve as further confirmation.
4. Enter the Trade
When price retraces into the Fair Value Gap, it typically signals a low-risk entry. Traders can take long or short positions, depending on the market structure, using the gap as a zone of interest.
- Long Entry: In a bullish market, wait for price to retrace to the Fair Value Gap and consider entering a long trade, anticipating that smart money will fill the gap before continuing the trend.
- Short Entry: In a bearish market, enter short positions when price retraces to fill the FVG, expecting the gap to act as a magnet for price before the downtrend resumes.
5. Set Stop-Loss and Take Profit Levels
Place your stop-loss just beyond the Fair Value Gap to minimize risk. For take-profit levels, target nearby liquidity pools or the next significant area of interest (e.g., previous highs or lows) where smart money may target.
Practical Example: Bullish Fair Value Gaps
Suppose a bullish price movement creates a gap between the low of one candle and the high of the next. This is a Fair Value Gap, and price may eventually retrace into that gap. Smart money traders will anticipate the retracement as institutions aim to fulfill their unexecuted buy orders before pushing the price higher.
Traders can enter long positions when price revisits the gap and ride the trend upwards, knowing that institutions are likely to resume the original move after filling in the gap.
Conclusion:
Fair Value Gaps are one of the most powerful concepts in smart money trading, offering insights into price imbalances created by institutional moves. When combined with an understanding of liquidity voids, these gaps provide traders with excellent opportunities to time their entries and exits based on institutional behavior.
By mastering the Ghosttraders methodology and learning to recognize Fair Value Gaps, liquidity pools, and liquidity voids, you can significantly improve your trading precision and profitability. These concepts, when applied correctly, allow you to trade alongside smart money rather than being caught on the wrong side of market manipulation.
This article blends the foundational knowledge of Fair Value Gaps with concepts of liquidity and liquidity voids to provide you with a structured approach to trading smart money movements.
