What Is a Fair Value Gap? A Simple Breakdown for Smart Money Traders
In recent years, the trading community, especially those interested in institutional or “smart money” concepts, has seen a rise in the popularity of advanced tools and strategies. Among them, one concept that has caught the attention of traders is the Fair Value Gap (FVG).
This concept is often mentioned in conjunction with institutional trading models. Fair value gaps provide a practical lens through which traders can identify imbalances in price, potential entry points, and areas of interest used by big players in the market. In this article, we’ll break down what a fair value gap is, how it works, how smart money uses it, and how you can start to use it for your own trading.
What Is a Fair Value Gap?
A Fair Value Gap (FVG) is a specific kind of price imbalance that occurs on a chart when there’s a sharp movement in one direction. It leaves a “gap” in trading activity. It signals that the market may have moved too quickly and didn’t allow buyers and sellers to interact fairly at all price levels.
In simpler terms, a fair value gap is the space between two candles that are not fully overlapped by a candle in between. It reflects a zone where price moved so fast that it skipped over price levels and created an inefficiency in the market.
These inefficiencies are often later revisited by price as the market seeks to return to “fair value.”
How to Identify a Fair Value Gap
A standard bullish fair value gap forms like this:
- Candle 1 (Bullish): Strong upward movement.
- Candle 2 (Bullish): Another strong upward candle that leaves a gap between the high of Candle 1 and the low of Candle 3.
- Candle 3 (Bullish or Bearish): The low of this candle does not fully fill the gap left by Candle 2.
In this case, the fair value gap is between:
The high of Candle 1 and the low of Candle 3
This gap zone becomes an area where price might return in the future to “rebalance” the market.
The same applies to bearish fair value gaps, but in the opposite direction.
Why Do Fair Value Gaps Matter?
Fair value gaps are important because they reflect price inefficiency—a condition that institutions and large players often seek to fill. In traditional technical analysis, you often hear the phrase “price fills the gap.” In smart money concepts, the Fair Value Gap is a visual representation of that fill process, but it is applied to candles rather than traditional chart gaps.
Here's why it is important:
1. They Often Act as Magnet Zones
The market tends to return to areas of inefficiency; this is why FVGs can act like magnets: they draw price back into them before the trend resumes.
2. Entry Points for Institutional Traders
Smart money doesn’t chase price. Institutions aim to enter trades where they get the most favorable pricing. FVGs often provide that zone.
3. Precise Risk Management
FVGs give clear levels to set entries and stops. For example, you could enter at the midpoint of the gap and place your stop just below the other end of the imbalance.
The Logic Behind Fair Value Gaps
The foundation of this concept is the idea of market balance.
- When the market is in equilibrium, buyers and sellers interact at all price levels.
- When it moves too fast (like during a news event or a major breakout), it skips certain price levels and creates an imbalance or inefficiency.
These areas are later tested as the market retraces to re-establish fair value.
This fits into the larger framework of smart money theory, which states that large players leave footprints in the market through things like:
- Liquidity grabs
- Imbalances
- Breakers
- Order blocks
Fair value gaps are one of these clues that institutions leave behind.
How Smart Money Traders Use FVGs
Here are three main ways traders use fair value gaps in a smart money trading strategy:
1. Entry Zones
Traders wait for the price to return to a fair value gap (especially after a break in market structure) and look for a reaction. These are often low-risk, high-reward trade setups.
2. Combination with Other Tools
FVGs are often combined with:
- Market structure breaks
- Liquidity zones
- Order blocks
- Fibonacci retracements This adds confidence to a trade and improves timing.
3. Trend Continuation Signals
When price re-enters a fair value gap but rejects it strongly, it may signal a continuation of the prevailing trend.
Example of How to Use FVG in a Trade
Let’s say you’re looking at EUR/USD on the 1-hour chart:
- The price makes a sharp move up and creates a bullish FVG.
- You mark the gap zone using the high of Candle 1 and low of Candle 3.
- After a few hours, price retraces into that gap.
- You wait for confirmation (e.g., a bullish candle pattern or a lower timeframe break of structure).
- You enter long at the gap with a stop below the low of the FVG and target the previous high. This approach provides a structured and rule-based entry and is perfectly aligned with how smart money operates.
FVG vs Traditional Gaps
Traditional gap trading often focuses on:
- Market open gaps (common in stocks)
- News-related gaps In contrast, FVGs don’t rely on the market being closed. They can form at any time during continuous price movement. This is why they can be used more efficiently in forex, crypto, and futures markets that trade nearly 24/7.
Best Timeframes to Use Fair Value Gaps
Fair value gaps appear on all timeframes, but how you use them depends on your trading style:
- Swing traders often use FVGs on the 1H, 4H, or daily charts.
- Day traders and scalpers prefer 1-min, 5-min, or 15-min charts to detect precise entries.
- Higher timeframes tend to produce more reliable FVGs, while lower timeframes are best for entry refinement.
Limitations and Cautions
Like any strategy, FVGs are not foolproof. Here are a few things to keep in mind:
- Not every gap gets filled. The market doesn’t owe you a retracement.
- Multiple FVGs may form. Use other tools to prioritize which are meaningful.
- Traps exist. Smart money may fake a fill, then reverse sharply. It’s best to use FVGs with context, not as standalone signals.
How to Mark FVGs on TradingView
You can manually mark FVGs with the rectangle tool, or use community-built indicators such as:
- FVG by LuxAlgo
- ICT Fair Value Gap script
Custom Smart Money Indicator Suites
These can highlight FVGs in real-time on your chart and save time during analysis.
Final Thoughts
Fair value gaps are a powerful addition to any price action or smart money-based trading strategy. They offer a unique way to visualize market inefficiencies and understand how institutional traders may be entering the market.
With this concept, you gain access to a more strategic and structured approach, far beyond random entries or emotional decisions.