6 Tips for Using Fair Value Gap Trading

Consider you’re navigating the world of Smart Money Trading, trying to find that edge against the relentless market waves. It’s easy to feel like you’re missing something critical, especially when others seem to know the secret handshakes. Fair Value Gap Trading could be that missing piece, offering a way to spot hidden opportunities in price gaps. This guide will help you understand these gaps and use them to maximize your trading potential.

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What is Fair Value Gap Trading

Fair value gaps (FVGs) are a concept that price action traders love to identify. These gaps occur when there’s an imbalance in the market, and buying and selling aren’t equal. When this happens, these gaps can act like magnets, and the price will often return to them before continuing in the same direction.

How to Spot an FVG on the Chart

Look for a big candle sandwiched between two smaller ones. The first candle sets the stage, the middle one makes a big move, and the last one signals where the gap might be filled. The space between these wicks is the fair value gap.

What Creates an FVG?

An FVG happens when price moves so fast in one direction that it skips over certain levels, leaving an untraded zone between the first and third candles. These gaps often appear during news-driven volatility or when big players make trades or trends are strong.

Why FVGs Matter

FVGs can be great opportunities for traders. Prices often return to fill the gap before resuming their previous trend. Knowing this can help traders make informed decisions and capitalize on the imbalance.

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How to Use Fair Value Gap in Trading in 6 Steps

1. Spotting a Valid Fair Value Gap

Start with a candlestick chart on a 5-minute, 15-minute, or 1-hour timeframe. You need to find a three-candle formation. The middle candle should be a large momentum candle. Look for a clean price gap where the highs and lows of the candles before and after do not overlap. Pro tip: The cleaner the gap, the more pronounced the imbalance.

2. Understanding the Market Context

Don’t just trade every gap you find. You need to think about the market’s condition. Is it trending or moving sideways? Does the Fair Value Gap line up with support or resistance zones? Are there any significant news events or fundamentals to consider? Use these insights to filter gaps based on market structure or Smart Money Concepts.

3. Letting Price Come Back to the Gap

Price often retraces back into the Fair Value Gap before moving on. In a bullish scenario, let the price dip into the gap. In a bearish setup, wait for the price to touch the gap from below. This is your moment to enter the trade.

4. Crafting Your Entry Strategy

You have two ways to enter the trade. For an aggressive entry, place a limit order at the start or middle of the FVG zone. Use this method when you’re confident about market direction. For a more cautious approach, wait for price action confirmation inside the gap. Look for a bullish engulfing pattern for a long entry or a bearish engulfing for a short one. Enter when you see the price starting to reject the FVG.

5. Setting Stop Loss and Take Profit

Your stop loss should be placed just below the FVG zone for long entries or above it for short entries. For extra safety, consider using a recent swing low or high. When it comes to taking profit, aim for at least a 1:2 risk-to-reward ratio. Look for liquidity zones, previous highs and lows, key support or resistance levels, or areas where imbalances get filled.

6. Managing the Trade

Move your stop loss to breakeven once you hit a 1:1 risk-to-reward ratio. For longer moves, trail your stop loss to lock in more gains. Scale out of your position at key levels to take partial profits.

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Benefits of Fair Value Gap Trading

Adaptability: Fair Value for Everything

Fair value trading stands out with its adaptability. Regardless of the asset type —whether it is stocks, bonds, or cryptocurrency —a fair value can be determined. This flexibility is a significant advantage over historical valuations, which can fall short when dealing with new or evolving asset classes. When an asset exists, its fair value can be calculated, providing traders with a versatile tool across various markets.

Accuracy: Keeping It Real

When you use fair value accounting, you get a highly accurate picture. It adjusts with price changes, reflecting the actual state of affairs. This isn't about what things used to cost—it's about what they're worth now. With this level of precision, traders can make informed decisions, knowing they're working with the most current data available.

Reflecting Actual Income

Fair value accounting does more than just track asset prices; it gives a clearer picture of a company's actual income. Unlike profit and loss statements, which can be manipulated, fair value offers a reliable view. This transparency enables traders to assess a company’s proper financial health, facilitating more informed investment decisions.

Asset Reduction: A Safety Net

Fair market accounting provides a lifeline in tough times. By allowing businesses to declare that an asset’s sale value was overestimated, it offers a way to correct course. This feature can help organizations navigate financial challenges, making it a valuable tool for maintaining stability when markets are volatile.

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6 Tips for Using Fair Value Gap Trading

1. Supercharge Your Trading Skills with AquaFunded

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2. Spot the Market Trend Like a Pro

Before jumping into Fair Value Gap trading, you need to figure out the market trend. In an uptrend, prices form higher highs and higher lows. In a downtrend, prices create lower highs and lower lows. This basic understanding will guide your trading decisions and help you find those lucrative Fair Value Gaps.

3. Use Premium and Discount Zones Wisely

To get the most out of Fair Value Gaps, you need to focus on premium and discount zones. In a downtrend, look for FVG in the premium zone. Conversely, in an uptrend, locate FVG in the discount zone. This strategy allows you to identify optimal entry points based on market conditions.

4. Identify the Big Player Candle

Finding the significant candle is key to spotting FVG. Look for a candle with a large body and small wicks. In an uptrend, look for a strong bullish candle with a wide range of movement. In a downtrend, look for a strong bearish candle with a wide range of movement. These candles serve as the foundation for identifying Fair Value Gaps.

5. Analyze the Surrounding Candles

Once you've identified the significant candle, examine the candles before and after it. These should not overlap with the large candle's body. This structure confirms the presence of a Fair Value Gap between the wicks of the first and third candles. It’s like piecing together a puzzle for that perfect trading entry.

6. Mark Your Fair Value Gap

Finally, pinpoint the Fair Value Gap. In an uptrend, the FVG is the gap between the first candle's high and the third candle's low. In a downtrend, the FVG is the gap between the low of the first candle and the high of the third candle. This step solidifies your trading strategy, allowing you to execute with confidence.

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