Fair Value Gap Simplified - Smart Money Course

Summary

This episode of 'Smart Risk Trading' explores fair value gaps, a key indicator of institutional money footprints, often overlooked by traders. It delves into the psychology behind these gaps, their role in market movements, and how they can be identified through candlestick patterns. The video explains the importance of liquidity zones and the cyclical nature of the market's tendency to fill gaps. It also provides criteria and rules for using fair value gaps effectively in trading strategies, emphasizing the need for a valid market structure break and the priority of gaps at market extremes.

Takeaways

• 📈 Fair value gaps are crucial for smart risk trading and often represent the footprint of institutional money in the market.
• 🔍 Identifying fair value gaps requires analyzing candlestick patterns and can be done in both bullish and bearish markets.
• 🌐 Market sentiment is driven by liquidity zones and fair value gaps, which are pivotal in market dynamics.
• 💧 Liquidity zones are vital for market momentum and are areas where the market seeks to accumulate liquidity.
• 🔑 A fair value gap is typically formed within a three-candle sequence and is noticeable when neighboring wicks do not overlap the middle candle's body.
• 🚫 In some cases, a four-candle sequence must be considered to accurately identify a valid fair value gap, especially when an inside bar is present.
• 🛑 The market tends to fill and rebalance gaps, creating a cyclical pattern that reflects its operation.
• 🧲 Pending orders within fair value gaps create a significant liquidity pool, attracting the price back to fill the gaps and continue the trend.
• ✅ To utilize fair value gaps, traders should look for price action when the price enters the gap to determine the direction of the next movement.
• 📉 In a bearish market, focus on fair value gaps in the premium zone for short positions, and in a bullish market, look at gaps in the discount area for long positions.
• 🔄 Fair value gaps at market extremes are prioritized for trade execution and should be considered one-time use after being mitigated by price action.

Q & A

What is a fair value gap in trading?

A fair value gap in trading represents a price area that the market tends to fill and rebalance, often considered as the footprint of institutional money in the market.

Why are fair value gaps important for smart money traders?

Fair value gaps are important for smart money traders because they play a pivotal role in executing well-informed trading opportunities and are a cornerstone in their strategies.

What are the two key factors that influence market movements according to the script?

The two key factors that influence market movements are liquidity zones, which serve as the lifeblood of the market, and fair value gaps, which the market consistently shows a tendency to fill.

How can traders identify fair value gaps from a candlestick perspective?

Fair value gaps are typically formed within a three-candle sequence and are noticeable as a large candle where the upper and lower wicks of the neighboring candles do not completely overlap the body of the middle candle.

What is the exception to identifying a fair value gap with a three-candle sequence?

The exception is when the first candle in a three-candle sequence is an inside bar candle, which forms within the preceding mother candle, requiring a four-candle sequence to identify a valid fair value gap.

Why do traders place limit orders below key zones during sharp market movements?

Traders place limit orders below key zones hoping that the price will make a deep pullback and activate their orders before resuming its upward movement, allowing them to enter the market at a better price.

How does the presence of pending orders within a fair value gap affect the market?

The presence of pending orders within a fair value gap creates a significant liquidity pool, which acts as a magnet for price, attracting it back to fill the void before resuming its trend.

What is the significance of identifying fair value gaps in different market conditions?

In a bearish market, traders should focus on fair value gaps in the premium zone for short positions, while in a bullish market, they should focus on gaps in the discount area for long positions.

What is the recommended approach for using a trading strategy or setup in a real account?

It is recommended to backtest a strategy or setup at least 100 times in a simulated environment before using it in a real account to ensure its effectiveness.

What is the role of an economic calendar in a trader's daily routine?

An economic calendar provides accurate and detailed information on upcoming economic events, which is crucial for a trader's fundamental analysis and planning of their trading activities.

How can traders utilize the fair value gap concept in market structure mapping?

Traders can utilize the fair value gap concept in market structure mapping by identifying potential gaps resulting from recent market momentum and waiting for the price to retrace to fill these gaps before continuing its primary trend.

Outlines

00:00

📈 Introduction to Fair Value Gaps and Market Dynamics

The video script introduces the concept of fair value gaps, which are often overlooked but are crucial for smart money traders. It explains that these gaps represent the footprint of institutional money and are pivotal for executing informed trading opportunities. The script outlines the structure of the episode, which will cover various types of candlestick fair value gaps, the psychology behind them, and the associated price actions. It also mentions the importance of market sentiment and the two key factors influencing price direction: liquidity zones and fair value gaps. The script provides an example of how the market tends to fill gaps and suggests that understanding these dynamics can lead to well-informed trading decisions.

05:01

🔍 Identifying Fair Value Gaps and Their Role in Market Movements

This paragraph delves deeper into the identification of fair value gaps from a candlestick perspective. It describes the typical formation of these gaps within a three-candle sequence, with an exception for a four-candle sequence when an inside bar candle is present. The script explains the concept of a fair value gap zone and how it is drawn on the chart, emphasizing the importance of considering the entire sequence for accurate identification. The paragraph also discusses the theory behind fair value gaps, using a three-candle sequence to illustrate how the market tends to fill gaps due to the accumulation of pending orders, which create a liquidity pool that attracts the price back to fill the gap.

10:01

📉 Utilizing Fair Value Gaps for Trading Opportunities

The script continues by discussing how fair value gaps can be utilized for trading opportunities. It explains the importance of the price action when the price enters the fair value gap, as it can indicate the direction the price is likely to take. The paragraph provides examples of how to identify fair value gaps on a chart, emphasizing the need to consider the context of the market's dominant direction. It also introduces the concept of backtesting strategies using the Trader Edge platform and demonstrates how to apply the fair value gap concept in market structure mapping. The script concludes with essential criteria and rules for using fair value gaps in trading, including the importance of a valid break of structure, focusing on gaps in specific zones, prioritizing gaps at market extremes, and considering gaps as one-time use areas.

Keywords

💡Smart Risk Trading

Smart Risk Trading refers to a strategic approach to trading that involves identifying and taking calculated risks based on market analysis and understanding of market dynamics. In the video, this concept is central to the discussion on fair value gaps, which are used as a tool for making informed trading decisions and minimizing potential losses.

💡Fair Value Gaps

Fair value gaps are areas on a price chart where there is a significant price movement that leaves a gap between the high and low of two consecutive candles. These gaps are often seen as the footprint of institutional money and are pivotal in executing well-informed trading opportunities. The video discusses how these gaps can be identified and used to predict future price movements.

💡Market Sentiment

Market sentiment is the overall attitude or tone of investors toward a particular security or market as a whole. It is a key factor that fuels market movements and is influenced by various elements such as liquidity zones and fair value gaps. The script mentions that understanding market sentiment is crucial for identifying the main factors that drive price direction.

💡Liquidity Zones

Liquidity zones are areas on a price chart where there is a high concentration of trading activity, which can generate momentum in the market. In the script, liquidity is described as the lifeblood of the market, playing a vital role in its overall dynamics and functioning.

💡Candlestick

A candlestick is a graphical representation used in a financial chart to show the opening, closing, high, and low prices of a security for a specific period. The video script explains how to identify fair value gaps from a candlestick perspective, noting that these gaps are typically formed within a three or four candle sequence.

💡Inside Bar Candle

An inside bar candle is a type of candlestick pattern where the entire body of a smaller candle is contained within the body of the previous larger candle. The script mentions that when an inside bar candle is present, it may be necessary to consider a four-candle sequence to accurately identify a valid fair value gap.

💡Price Action

Price action refers to the movement of a financial instrument's price over time, reflecting the collective sentiment of all market participants. The video discusses how price action, particularly when it enters a fair value gap, can be used to determine the direction of future price movements.

💡Break of Structure

A break of structure in trading refers to a situation where the price of a security moves beyond a previously established pattern or level, indicating a potential change in trend. The script emphasizes that for fair value gaps to be considered for trades, there must be a valid break of structure or change of character in the market.

💡Backtesting

Backtesting is the process of testing a trading strategy using historical data to see how it would have performed in the past. The video script recommends backtesting a strategy at least 100 times before using it in a real account, which is a critical step in validating the effectiveness of trading strategies.

💡Premium Zone

In the context of the video, the premium zone refers to areas in the market where prices are considered to be higher than their fair value. The script advises focusing on fair value gaps in the premium zone when seeking to initiate short positions in a bearish market.

💡Unmitigated Fair Value Gaps

Unmitigated fair value gaps are gaps that have not yet been filled by the market price. The script states that these gaps hold a higher priority for trade execution and should be considered one-time use, focusing on the trading opportunity when the price first enters the gap.

Highlights

Smart risk trading involves identifying proper and high-quality fair value gaps to avoid significant losses.

Fair value gaps represent the footprint of institutional money and are pivotal for executing informed trading opportunities.

The market tends to fill and rebalance gaps as part of its natural dynamics.

Liquidity zones are vital for market momentum and are linked to fair value gaps.

Fair value gaps are typically formed within a three-candle sequence on a price chart.

A four-candle sequence may be necessary to identify a valid fair value gap when an inside bar candle is present.

Fair value gaps can be identified regardless of market direction and are applicable across various timeframes.

The market's tendency to fill gaps is driven by the accumulation of pending orders creating liquidity pools.

Fair value gaps act as magnets for price, attracting it to fill the gaps before resuming the trend.

Traders can use fair value gaps to identify potential entry points for trades.

The presence of fair value gaps can indicate potential reversals or continuations of market trends.

Price action within the fair value gap can signal the market's next movement direction.

Fair value gaps at market extremes are given higher priority for trade execution.

Unmitigated fair value gaps are considered one-time use for trading opportunities.

A valid break of structure or change of character is essential before using fair value gaps for trades.

In a bearish market, focus on fair value gaps in the premium zone for short positions; in a bullish market, focus on gaps in the discount area for long positions.

Backtesting trading strategies using platforms like Trader Edge is recommended before live trading.

Transcripts

hey Traders and welcome to another

episode of smart risk trading without

the skill to identify proper and

highquality fair value gaps can be

extremely risky and may result in

significant losses fair value gaps often

overlooked by many represent the

footprint of institutional money in the

market they play a pivotal role in

executing well-informed trading

opportunities and are a Cornerstone in

the strategies of smart Money traders in

today's episode we are diving into

various Candlestick fair value Gap types

the psychology behind them and the price

actions associated with them that you

might encounter in the market from basic

to Advanced but that's not all we'll

break down the key criteria and rules

that elevate a fair value Gap into a

winning trade so Traders if that's

something you're interested in please

give this video a thumbs up to show your

support and subscribe to our Channel if

you are new see you after

[Music]

intro

[Music]

welcome back Traders so let's get

started before diving into the basic and

advanced features of the fair value gaps

let's have a quick breakdown of Market

sentiment and see what is the main

factor that fuels the market and what is

the major psychology behind the market

movement the Dynamics behind Market

movements can be boiled down to two key

factors that consistently influence

price Direction the first element is the

the liquidity zones Market continually

seeks to sweep liquidity to generate

momentum essentially liquidity serves as

the lifeblood of the market playing a

vital role in the Market's overall

Dynamics and functioning we have

extensively covered how to identify

liquidity zones in previous videos which

you can find Linked In the description

if you haven't watched it yet you can

easily access it through the description

of this video the second factor is the

fair value gaps the the market

consistently shows a tendency to fill

and rebalance the gaps present within

it if you look at this example you can

notice that the price sharply dropped

with inefficiency leaving a fair value

Gap behind subsequently the price moved

back up and filled the fair value Gap

simultaneously it also moved upward to

clear out external

liquidity once external liquidity was

swept the price reversed back down to

fill the most recent fair value Gap

this cyclical pattern reflects how the

market operates where price tends to

both clear accumulated liquidity and

fill fair value gaps now let's continue

and explore how we can identify fair

value gaps from the Candlestick

perspective in the

Market Fair Value gaps are typically

formed within a three candle sequence

and are easily noticeable on the chart

as a large candle the distinguishing

feature is that the upper and lower

Wicks of the neighboring candles do not

complete completely overlap the body of

the middle candle this creates what we

call the fair value Gap Zone which

essentially fills the space between the

Wix and is drawn on the body of the

middle

candle however there is an exception in

that we must consider a four candle

sequence to identify a valid fair value

Gap when the first candle in a three

candle sequence is an inside bar candle

and forms within the preceding mother

candle it becomes necessary to analyze a

four candle sequence to accurately

identif ify the valid fair value Gap

Zone in situations like this if we do

not consider the mother candle when we

are drawing the fair value gap on the

chart our identified Zone will not be

optimized or valid for example in this

scenario if we solely focus on this

three candle sequence to identify the

fair value Gap without taking into

account the presence of this red candle

the identified fair value Gap would be

incorrect these concepts are applicable

to bearish markets as well it's

important to note that these principles

can be applied apped across various time

frames and any price action based chart

now let's see what is the theory behind

the fair value

gaps consider a three candle sequence as

Illustrated let's say that this bullish

Candlestick sequence which created a

significant imbalance in the market

occurred in a higher time frame to

analyze this three candle sequence from

the market structure perspective let's

zoom into a lower time

frame here we see that the price created

a bullish structure similar to the one

Illustrated as mentioned earlier the

market consistently shows a tendency to

fill and rebalance the gaps present

within it now let's take a closer look

to understand the rationale behind this

phenomenon as you can see the price

created a successive bullish structure

to the upside with great momentum driven

by high buying pressure and a lack of

sellers in the market when Traders

encounter such sharp movements and miss

out on a great buying opportunity they

often play Place their by limit orders

below key zones such as order blocks and

demand areas hoping that the price will

make a deep pullback and activate their

orders before resuming its upward

movement this scenario accumulates a lot

of pending buy orders in this area

creating a significant liquidity pool

awaiting to be swept by the market

inside the fair value Gap so Traders

fair value gaps are filled with many buy

or sell orders creating a substantial

liquidity pool inside the Gap this is

the primary reason reason why the price

is likely to return to fill the gaps and

then continue its momentum with even

greater strength the presence of these

pending orders within the fair value Gap

acts as a magnet for Price attracting it

back to fill the void before resuming

its Trend this might provide a great

trading opportunity for us but before we

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description imagine a scenario where the

price experiences a downward movement in

this case a fair value Gap also known as

a liquidity Gap emerges due to the

absence of buying pressure spanning

across that specific downward price

movement please note that the

identification of the Gap is solely

based on considering the impulse up or

impulse down candle along with the

adjacent candles other candles outside

this range do not play a role in

determining the

Gap these pockets of liquidity voids

hold significant importance as they can

serve as potent entry points due to the

the Market's attraction to liquidity

when the price is inclined to move

downward it aims to clear the potential

liquidity zones above it consequently

these zones become favorable regions

where the price might witness an upward

movement only to eventually fill the

gaps and then continue its bearish

momentum with greater strength as we

understand the psychology behind the

fair value gaps now let's see how we can

take advantage of them in identifying

Market's upcoming movement and

Direction the key factor that we can

consider to determine price direction is

the price action that unfolds when price

enters the fair value Gap if the price

respects the fair value Gap and shows a

rejection towards the upside it suggests

that the price will likely aim to move

upward to reach the most recent buy side

liquidity which is accumulated above the

recent High conversely if the price does

not show a reaction upon reaching the

fair value gaps it indicates that the

price is more likely to move downward to

Target the sell-side liquidity

accumulated below the recent

low to solidify our understanding of

fair value gaps let's see how we should

identify them on the

chart consider a series of bullish

candles as Illustrated let's begin our

analysis from the bottom of the candle

series here we have a three candle

sequence represented by these three

green candles if we draw lines from the

upper Wick of the first candle and the

lower Wick of the third candle we see a

gap between them

moving forward we encounter another fair

value Gap within this subsequent three

candle

sequence however price subsequently

experienced a downward push ultimately

filling all the gaps in the continue we

witness a strong upward momentum in

price now where is our next fair value

Gap by drawing lines from the upper Wick

of this bearish candle and the lower

Wick of the following green candle we

identify another fair value Gap created

between the

candles next a little bit higher we have

another three candle sequence however if

we draw lines once again we see that

there is no gap between the candles and

there is no fair value Gap to

identify once again if we consider these

three candles and draw lines from the

upper Wick of the first candle and the

lower Wick of the last candle we see

that there was a gap between the candles

which is mitigated and rebalanced with

these two

candles next we have another three

candle sequence at the Top If we draw

lines we can easily identify another

unmitigated fair value Gap

here so in this bullish candle series

we've identified two unmitigated fair

value gaps one located at the top and

one located at the

extreme the price tends to push back

down once again to fill the liquidity

voids in these fair value gaps and then

continue its bullish momentum price can

reverse from the upper fair value gap or

it can push lower to mitigate the fair

value value Gap at the extreme both

scenarios could happen in the market the

same Concepts can be applied to the

bearish scenario now let's take a quick

breakdown of the real chart and see how

we can utilize the fair value Gap

Concept in Market structure mapping

before using a strategy or setup in a

real account it's recommended to back

test it at least 100 times to help you

with this critical step we use the

trader Edge platform for back testing

our exclusive trading strategies and

setups if you're interested in using

Trader Edge as your back testing tool be

sure to check out the link in the

description

below so here we have euro dollar 1our

chart on the screen as you can see

Price's dominant direction is bearish

for identifying fair value gaps with

high probability firstly we need to wait

for the price to form a valid break of

structure here we see that the price

pushed to the downside and has broken

the previous major low closing below

it thus we have we have a valid break of

structure next let's identify potential

fair value gaps resulting from the

recent bearish momentum in the market in

a bearish market it's crucial to analyze

the chart from top to bottom to identify

fair value gaps whereas in a bullish

Market the analysis proceeds from bottom

to top starting from this high point

we'll begin our

analysis here we encounter a three

candle sequence at the market extreme by

drawing lines from the lower Wick of the

first candle CLE and the upper Wick of

the third candle we identify a distinct

unmitigated fair value Gap situated at

this extreme

Point upon closer examination of the

chart it becomes evident that there are

no additional fair value gaps within

this internal bearish impulse move now

we can see an inside bar candle pattern

that formed just before the price

created inefficiency in the market with

this large momentum

candle as previously mentioned in cases

like this identifying a fair value Gap

requires analyzing a four candle

sequence instead of a three candle

sequence to highlight a valid and

optimized Zone therefore we should draw

lines from the lowest point of the

mother candle and the upper Wick of the

fourth candle to highlight the valid

fair value Gap however it's crucial to

note that this fair value Gap is

mitigated by the price and we cannot

consider it as a trading

opportunity so inside this bearish

impulsive movement we've identified two

fair value gaps one of them was

mitigated by the price action while the

other remains unmitigated located at the

Extreme as previously discussed prices

are more likely to return to fill and

rebalance the gaps before resuming their

primary Trend therefore what we should

do here is to wait for the price to

retrace back up to fill the gaps it has

left behind before continuing its

bearish

momentum let's see what happens

next as you can see the price pushed

back up again and after filling the fair

value gaps reversed its direction and

resumed its bearish

momentum now let's move into essential

criteria and rules that we need to

consider to identify and use fair value

gaps to execute trades in the market and

understand how we can use them to our

advantage rule number one it emphasizes

that for considering a fair value gap

for executing trades and as an entry

point the price must lead to a break of

structure or a change of character in

the market without a valid break of

structure and change of character we

must not execute any trades based on

Fair Value gaps because these elements

are essential signals that indicate

whether the market will continue in its

initial direction or experience a

reversal rule number two in a bearish

market our focus should be exclusively

on Fair Value gaps situated in the

premium Zone when seeking to initiate

short positions conversely in a bullish

Market our attention should be directed

solely toward fair value gaps positioned

in the discount area to execute long

positions rule number three fair value

gaps situated at Market extremes hold a

higher priority when it comes to trade

execution compared to those found

elsewhere rule number four it must be

unmitigated fair value gaps areas are

considered one-time use meaning we focus

on the trading opportunity when price

first enters a fair value Gap once a fvg

has been mitigated we do not consider it

as an area of interest for fure

trading that's it Traders thank you for

watching this video I hope you found it

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