When trading in the stock market, you might have noticed sudden price movements that seem unusual. These gaps in price action often leave traders wondering what caused them and whether they present an opportunity. One such concept that explains these price gaps is the Fair Value Gap (FVG).
If you’re an Indian investor looking to understand how FVGs work and how they can be used in trading, this article will explain everything in simple terms. We’ll cover what fair value gaps are, why they form, and how traders use them to make informed decisions.
Fair Value Gap (FVG) Meaning
A Fair Value Gap (FVG) is a price range on a chart where an imbalance exists between buyers and sellers. This gap occurs when there is a sudden and strong movement in price, leaving a void where little or no trading took place.
In simpler terms, a fair value gap is like a missing piece in a puzzle. The market usually aims to “fill” this gap at some point, meaning prices may return to this level in the future.
Read More AboutWhat are Gaps in Stock Market?
Why Do Fair Value Gaps Form?
Fair value gaps typically occur due to:
- High market volatility – Sudden buying or selling pressure leads to a rapid price movement.
- News events and economic data – Important announcements, such as interest rate decisions by the RBI or corporate earnings reports, can cause strong price fluctuations.
- Institutional trading – Large investors, such as mutual funds or hedge funds, may place big orders that move the price quickly, leaving a gap behind.
How to Identify a Fair Value Gap?
To spot a fair value gap on a price chart, traders often use candlestick patterns. A fair value gap typically appears in a three-candle formation, where:
- The first candle moves strongly in one direction.
- The second candle continues the move, creating a large gap between the first and third candle.
- The third candle doesn’t fully overlap with the first, leaving a “gap” in price action.
For example:
- If a stock jumps from ₹100 to ₹110 without much trading in between, this ₹10 gap is considered a fair value gap.
Visualising a Fair Value Gap
Imagine a stock is trading at ₹500. Suddenly, due to strong buying, it jumps to ₹520 in one move. This sharp increase leaves a price gap where very few transactions occurred between ₹500 and ₹520.
Traders will watch this level because prices may return to the gap area before continuing their trend.
Read More AboutWhat is Fair Value of Stocks?
How Do Traders Use Fair Value Gaps?
Fair value gaps are important because they indicate areas where price is likely to revisit. Traders use these gaps in multiple ways:
1. Trading Fair Value Gaps as Support or Resistance
- If the price returns to the fair value gap from above, it may act as support, meaning traders might buy in this area.
- If the price approaches the fair value gap from below, it may act as resistance, leading to selling pressure.
2. Using FVGs for Entry and Exit Points
- Entry Point: Traders may wait for the price to revisit the fair value gap before entering a trade.
- Exit Point: If a stock is in an uptrend but there is an FVG below, traders might set a target at the gap to take profits.
3. Combining FVGs with Other Indicators
While fair value gaps are useful, they work best when combined with other indicators like:
- Support and resistance levels – To confirm whether the price will reverse or continue.
- Moving Averages – To check overall market trends.
- RSI (Relative Strength Index) – To see if the market is overbought or oversold.
Fair Value Gap Example
Let’s say Nifty 50 is trading at ₹19,500. Suddenly, due to positive economic news, it jumps to ₹19,700 within minutes. However, very few trades happened between ₹19,500 and ₹19,700.
This creates a fair value gap.
Later, when the excitement settles, the price may drop back to ₹19,500 to “fill” the gap before continuing higher.
Traders who understand this concept may wait for the price to revisit the gap before entering their trades.
Fair Value Gaps in Different Markets
1. Fair Value Gaps in Stock Trading
Stocks like Reliance, HDFC Bank, and Infosys often experience fair value gaps due to earnings reports or major announcements.
2. Fair Value Gaps in Forex
In currency markets, news events such as RBI interest rate decisions can cause large gaps in currency pairs like USD/INR.
3. Fair Value Gaps in Crypto
The crypto market is highly volatile. Coins like Bitcoin and Ethereum frequently form fair value gaps, especially after big news events or regulatory announcements.
Should You Trade Fair Value Gaps?
Fair value gaps can be useful, but trading them requires patience and proper risk management.
Pros of Trading FVGs
- Helps identify potential price reversals.
- Can improve trade entry and exit points.
- Works well when combined with other indicators.
Cons of Trading FVGs
- Price may not always return to fill the gap.
- Requires proper risk management.
- Can be misleading in highly volatile markets.
Conclusion
Fair value gaps (FVGs) are an important concept in trading that helps traders understand price imbalances. For Indian investors, recognising these gaps can improve decision-making when trading stocks, forex, or even cryptocurrencies.
However, FVGs should not be used alone. Combining them with other technical analysis tools can increase the chances of success.
If you’re new to trading, try spotting fair value gaps in historical charts. Over time, you’ll get better at using them to improve your trading strategy.
FAQs
What is a Fair Value Gap in trading?
A fair value gap is a price range where little to no trading has occurred due to a sudden price movement.
How do I identify a Fair Value Gap?
Look for three-candle formations where the second candle creates a gap between the first and third.
Do Fair Value Gaps always get filled?
Not always, but in many cases, the price revisits the gap before continuing in the original direction.
Is trading Fair Value Gaps risky?
Like any trading strategy, fair value gaps have risks. Using stop-loss orders and combining them with other indicators can help reduce risk.
