Understanding Fair Value Gaps (FVG) - ICT Concepts

Summary

In this video, the creator explains the concept of fair value gaps, highlighting their identification and significance in trading. Fair value gaps are defined as gaps between the high of the first candle and the low of the third candle (or vice versa) across a three-candle pattern. The video also covers the terms 'sibi' (sell-side imbalance) and 'bissy' (buy-side imbalance), and their relation to fair value gaps. Additionally, it explores the concept of consequent encroachment, the invalidation of fair value gaps, and their potential inversion into support or resistance. The video concludes by distinguishing fair value gaps from volume imbalances and typical gaps.

Takeaways

• 😀 Fair Value Gap (FVG) is a three-candle pattern where the low of the first candle doesn't overlap with the high of the third, or the high of the first candle doesn't overlap with the low of the third.
• 😀 A City represents a sell-side imbalance or inefficiency, indicating a bearish FVG, where sell-side was offered but not bought.
• 😀 A Busy represents a buy-side imbalance or inefficiency, indicating a bullish FVG, where buy-side was offered but not sold.
• 😀 Consequent Encroachment (CE) refers to the 50% area of a FVG, which is a key level for understanding price behavior within the gap.
• 😀 When price closes outside of the consequent encroachment, it invalidates the FVG, signaling that the price is not respecting the gap.
• 😀 Inversion of an FVG occurs when price closes through a gap and then uses that same gap as support or resistance upon revisiting it.
• 😀 A volume imbalance is different from a gap, as it represents a price difference between the closing and opening prices, with trading activity present in between.
• 😀 Gaps, unlike volume imbalances, have no trading overlap, representing a more significant price movement or inefficiency.
• 😀 When price returns to fill a fair value gap, there are three possible reactions: price may either continue in the opposite direction, reach the consequent encroachment, or fill the gap entirely and continue in the trend.
• 😀 The respect for fair value gaps is confirmed when price reaches into them but does not close past the consequent encroachment. Once a close occurs past the CE, the gap loses its significance.

Q & A

What is a Fair Value Gap (FVG)?

A Fair Value Gap is a three-candlestick pattern where the low of the first candle does not overlap with the high of the third candle, or the high of the first candle does not overlap with the low of the third candle. This creates an imbalance in the market, signaling a potential price movement.

How do you identify a Fair Value Gap in a chart?

To identify a Fair Value Gap, extend the low of the first candle to the right and the high of the third candle. If there is no overlap between the two, it creates a gap. Similarly, if the first candle's high does not overlap with the third candle's low, this too creates a gap.

What are 'Cities' and 'Busies' in trading?

A 'City' refers to a sell-side imbalance, or a bearish Fair Value Gap, where the sell side was offered but the buy side wasn't. A 'Busy' refers to a buy-side imbalance, or a bullish Fair Value Gap, where the buy side was offered but the sell side wasn't.

What does 'Consequent Encroachment' refer to in the context of a Fair Value Gap?

The Consequent Encroachment is typically the 50% level of a Fair Value Gap. It acts as a critical threshold, helping traders identify if the price is respecting the gap. If price moves past this point, it may signal that the gap is no longer valid.

How does the Consequent Encroachment influence the validation of a Fair Value Gap?

When price returns to a Fair Value Gap, reaching or respecting the Consequent Encroachment level is important for validating the gap. If the price closes beyond this level, it suggests the gap might be invalidated, meaning the price may not revert as expected.

What is the process of Fair Value Gap Inversion?

Fair Value Gap Inversion occurs when a previously respected gap, such as a City (bearish gap) or Busy (bullish gap), is breached. Once the price moves through the gap, the gap can turn into support (if it was a City) or resistance (if it was a Busy). This effect doesn't always occur immediately and can happen after a period of consolidation.

How do Fair Value Gaps help in price prediction?

Fair Value Gaps indicate areas where the market has moved too quickly, and price often returns to fill these gaps. Traders use these gaps to anticipate potential price reversals or continuation, depending on whether the gap holds or gets invalidated.

What is the difference between a Gap, Volume Imbalance, and a Fair Value Gap?

A Gap refers to the absence of trading between two candles, where there is no overlap of high and low. A Volume Imbalance, however, has some overlap between the high and low but creates a gap in the closing and opening prices. A Fair Value Gap is a specific type of gap that signals market inefficiency.

How can a previously respected Fair Value Gap become invalidated?

A Fair Value Gap is invalidated when the price moves through it and closes beyond the Consequent Encroachment level or outside the gap. When this happens, it indicates that the price is no longer respecting the gap, and it may not act as a strong support or resistance level anymore.

What happens when price returns to a City or Busy after it has been invalidated?

When price returns to an invalidated City (sell-side imbalance) or Busy (buy-side imbalance), the gap may no longer act as expected. For example, a City that was once a bearish gap may turn into support, while a Busy that was once a bullish gap may turn into resistance.