This quick guide will tell you exactly what Fair Value Gap means. I am going to show you how you can spot and trade this type of pattern as well as how to add custom indicators to your chart that will make finding them even easier.
What Is A Fair Value Gap
A Fair Value Gap is an imbalance in the market. It takes place in a series of 3 candles when the middle candle gaps up or down. This signals strong buying or selling pressure in the direction of the gap. You can see exactly what this looks like illustrated in the drawing below.
When a gap occurs the wicks of the candles do not overlap each other. What this means is when the market is moving very fast it creates an imbalance where the sellers and buyers outpace each other.
As this imbalance happens, the markets are attracted to this area. In the future the price can come back to test this level to try and rebalance the market. You can use this to your advantage which will be explained in the next section.
How To Use The Fair Value Gap Strategy
To use the Fair Value Gap Strategy you need to spot these gaps as they happen. In the image above is a daily chart of the SPY Index where you can see the gaps outlined in the gray boxes. The arrows show where the price eventually comes back to this level. When you spot a gap you can try to trade the restest as this will be a key area of support or resistance.
You do not want to enter these trades blindly. Watch how the price reacts and watch the volume as well. Use proper risk management when placing trades which you can read more about here Simple Guide To Using Proper Risk Management When Trading.
Many trading platforms have indicators that will spot fair value gaps for you and display them on your chart. This can be particularly useful and save you time. Outlined below is how to do that on both Tradingview and Thinkorswim. For most other platforms it will be a similar process.
Tradingview has loads of custom indicators people have created and shared that you can use. On Tradingview simply going to the indicators tab and searching “fair value gap” will give you many options to choose from.
Thinkorswim does not have a fair value gap indicator pre-installed that you can add to a chart but you can import one. Here is a fair value gap indicator you can download. Once downloaded simply open up studies on Thinkorswim and click import.
This was a simple explanation on the basics of how to trade the fair value gap strategy. If you found this article useful click here to learn about more trading strategies.