Most Traders Don’t Understand This About FVGs

Summary

In this video, the concept of fair value gaps (FVG) in trading is explored, explaining their importance in market efficiency. A fair value gap is a price imbalance created by a three-candle sequence, signaling an area where price has moved quickly in one direction, leaving an inefficiency. The video delves into the three types of fair value gaps—bullish, bearish, and consolidation—and how to identify high-probability setups. It also highlights common pitfalls, such as ignoring higher time frames or trading in trapped order flow, and offers strategies for improving trading decisions with the goal of creating more consistent and profitable outcomes.

Takeaways

• 😀 Fair value gaps (FVGs) are price imbalances created by a three-candle sequence where the middle candle has a gap between its wicks, indicating an inefficiency in the market.
• 😀 FVGs can be bullish (buy-side imbalance) or bearish (sell-side imbalance), and they represent areas where the market seeks to rebalance and create more efficient price action.
• 😀 Think of FVGs as gaps in the market that need to be filled, like a paint roller running out of paint and then needing to return to continue the stroke.
• 😀 There are three main types of FVGs: breakaway gaps, rejection gaps, and consolidation gaps. Each type has different probabilities of being retraced or holding.
• 😀 Breakaway gaps occur when the third candle expands and closes above the second candle’s high, showing strong momentum. These gaps are less likely to be retraced.
• 😀 Rejection gaps are formed when the third candle shows a significant reversal, often indicating that the market is not ready to continue in the original direction.
• 😀 Consolidation gaps are high-probability gaps, where the third candle consolidates, signaling indecision and potential for price to retrace and continue in the original direction.
• 😀 Focusing on high-probability FVGs helps avoid trades with low success rates and reduces frustration when gaps fail to get filled.
• 😀 Avoid common trading pitfalls like ignoring the higher time frame trend, trading against the trend, and trading inside trapped order flow, which leads to choppy market conditions.
• 😀 Price can retrace into any type of FVG (even breakaway or rejection gaps), but market conditions may make this less likely, so always be prepared for unpredictability in trading.

Q & A

What is a fair value gap (FG) in trading?

A fair value gap (FG) is a price imbalance that appears in price action, typically formed when a three-candle sequence occurs where the middle candle's wicks do not overlap with the wicks of the candles before and after it. This gap shows an inefficiency in the market, indicating a rapid price movement with no balance between buyers and sellers.

Why are fair value gaps important in trading?

Fair value gaps are important because they represent inefficiencies in the market. Since the market is driven by efficiency, these gaps provide an opportunity for price to retrace and fill the gap, allowing the market to offer fair value to other participants before continuing in the same direction.

How does a bullish fair value gap differ from a bearish one?

A bullish fair value gap occurs when price moves higher, leaving an imbalance on the sell side. This is called a 'buy-side imbalance' or 'sell-side inefficiency.' A bearish fair value gap happens when price moves lower, creating an imbalance on the buy side, called a 'sell-side imbalance' or 'buy-side inefficiency.'

What role does the third candle in a fair value gap play?

The third candle in a fair value gap is crucial because it helps determine the probability of the gap being retraced. If the third candle is a consolidation candle, it signals that the gap has a higher chance of being filled. If the third candle is an expansion candle, it suggests a lower probability of retracement, and if it’s a rejection candle, it indicates significant opposing market intentions, leading to a lower probability of gap filling.

What is the difference between a high probability fair value gap and a low probability one?

A high probability fair value gap typically features a third candle that is a consolidation candle, showing neutral market intention. In contrast, low probability gaps involve either breakaway gaps, where the third candle shows strong expansion, or rejection gaps, where the third candle shows significant rejection against the prevailing trend.

What should traders avoid when trading fair value gaps?

Traders should avoid trading against the overall market trend, which can be identified through top-down analysis. They should also avoid trading inside trapped order flow, where price is caught between opposing market forces. Additionally, traders should be cautious around major economic news events, such as NFP, FOMC, or CPI, as these can lead to unpredictable volatility.

What is 'trapped order flow' and why should it be avoided?

Trapped order flow occurs when price is stuck between opposing forces, like a higher time frame bullish fair value gap (discount) and a bearish fair value gap (premium). In this situation, price lacks clear direction, leading to choppy, sideways movement. Trading in this scenario can result in failed setups or significant delays.

What is the significance of conducting a proper top-down analysis?

A proper top-down analysis ensures that traders are not trading against the larger trend. By analyzing higher time frames, traders can avoid making trades that go against the dominant market direction, reducing the risk of failure. For example, trading a bullish 15-minute fair value gap in a bearish daily market context could lead to poor outcomes.

Why is patience important in trading fair value gaps?

Patience is essential in trading fair value gaps because traders should not chase the market. If price moves away from a fair value gap without offering a clear entry, it is better to wait for the next setup rather than forcing a trade. Success in trading comes from discipline and waiting for optimal conditions, not rushing into trades.

Can price retrace into a breakaway or rejection gap and still move in the expected direction?

Yes, price can retrace into a breakaway or rejection gap and still move in the expected direction. However, this is not guaranteed, as market conditions can vary. While high probability gaps often fill, low probability gaps might fail. It’s important to stay aware that the market is not perfect, and no setup is 100% reliable.