Transcription
There are hundreds of smart money concepts floating around the internet today. Order blocks, breaker blocks, supply and demand zones. But if you force me to just trade with one concept out of everything in SMC, I would pick fair value gaps. Because fair value gaps are not just another strategy. They are the foundation that almost every other concept relies on.
If you understand how to read fair value gaps properly, you'll start to see three things. One, where price is likely to move. Two, where institutions enter the market. Three, and where the next opportunity will form. In this video, we're going to break down everything you need to know about fair value gaps, from the basics all the way down to the nitty-gritty details that most traders miss. And by the end of this video, you'll understand why this simple three candlestick pattern is one of the most powerful tools in trading.
Why does fair value gaps matter? There are thousands of trading concepts out there. But if you look closely at how most smart money strategies work, you'll realize something interesting. Almost every single one of them becomes more reliable when aligned with a fair value gap. Number one, order blocks become stronger. Two, liquidity sweeps becomes cleaner. Three, sniper entries becomes more precise.
That's because fair value gaps represent an imbalance in the market and the markets are consistently trying to rebalance inefficiencies. That is why institutions leave them behind. So instead of thinking about fair value gaps as just another chart pattern, I want you to think of them differently. Think of them as footprints of aggressive institutional buying or selling. They show you where the market moved too quickly, leaving an imbalance behind. And very often price will return to these areas.
So what is a fair value gap? Let's start with the basics. So for those of you guys that are more advanced, bear with me. A fair value gap is a three candlestick formation that represents a market imbalance. This imbalance happens when price moves so aggressively that not enough trading occurs within a certain price range. We identify that gap by looking at candle one and three. For a bullish fair value gap, the gap exists between the high of candle one and the low of candle three. For a bearish fair value gap, the gap exists between the low of candle one and the high of candle three. This gap represents an inefficiently traded area where price moved too quickly. And because the market tends to rebalance inefficiencies, price often returns to these zones later. However, identifying the patterns is only the beginning. The real edge comes from understanding what these gaps reveal about the market's intent. Let's move on.
Most traders treat fair value gaps as just another entry model or just another chart pattern. But that's actually the wrong way to think about them. Fair value gaps reveal something deeper. They reveal the intention of price. Every time the market creates a fair value gap, it is showing you that aggressive orders pushed in that direction. Think of them as footprints left behind by large financial institutions. Whenever you see a fair value gap appear on your charts, ask yourself, what is the market trying to do? The presence of fair value gaps tell you where price likely wants to continue in that same direction. But something equally important and something very few traders talk about is the absence of fair value gaps. Sometimes the non-creation of new fair value gaps can signal that momentum is weakening. And once you understand how to read both situations, the chart starts to make a lot more sense. Let me show you exactly what I mean.
Let's take a look at a real example. In this case, we're looking at XAUUSD on the 1-hour time frame. First thing you notice is that price creates a bearish fair value gap. Shortly after that, another bearish fair value gap forms. When this happens, it reinforces something important, showing us that the market is still intending to move lower. This is because the continued creation of bearish fair value gaps indicates persistent selling pressure. From here, a simple trade idea would be to place a sell limit at the beginning of the fair value gap and target the sellside liquidity below. And in this example, this trade produces roughly a 4R.
But here's where it starts to get interesting. After price takes the sellside liquidity, we get another bearish fair value gap. However, no new bearish fair value gap forms afterward and we instead close above the new bearish fair value gap. And this is the key. When new fair value gaps stop forming, it suggests that bearish momentum is fading. The market's intention is no longer to continue downwards. And what happens next? Price reverses and moves towards the buyside liquidity instead.
Let's talk about something that dramatically improves fair value trading. Many traders only focus on price only, but time plays a huge role in how the markets move. Let's take a look at another example here. Here we have a daily fair value gap. On this daily candle, price has already traded into the daily fair value gap. At first glance, you might think, well, the gap is already tapped and that means it's no longer useful. But that's not necessarily true. To understand why, we need to zoom into the 1-hour time frame.
On the 1-hour chart, price trades into the daily fair value gap at 1 p.m. EST. This timing is important because 1 p.m. EST falls into what I consider late in the trading day. For my model, anything after 11 a.m. EST is considered late in the day. And when this happens, we can expect something interesting. Often the markets will: one, sweep previous daily liquidity and two, then expand in the intended direction during the next day's active sessions like the Asian, London, or the New York session. And this is exactly what happens here. The next day price swept the previous day's low then explodes higher during the high volume trading hours. Again, fair value gaps forming afterwards reinforce the bullish intentions of price.
Let's talk about the most misunderstood part of fair value gaps. The three candlestick pattern itself. Most traders notice something frustrating. Sometimes you spot a fair value gap, but price never trades back into it. Instead, price just continues exploding higher or dumping lower without giving you an entry. So, why does this happen? The answer lies in the relationship between candle two and three. The second candle is the expansion candle. It represents aggressive order flow. But the third candle determines whether the market is likely to retrace into the fair value gap. Think of the third candle as priming the next candle for a high probability retracement. Candle three should not invalidate the expansion candle's structure. When this condition is met, price is often primed to return to the gap before continuing.
Let's look at two examples. First, let's take a look at the 15-minute time frame on gold here. In this case, price has established a clear bullish trend and has come back down to retest a 4-hour bullish fair value gap. Price then sets in a new bullish change of character on the 15-minute time frame, after retesting the 4-hour bullish fair value gap. Lastly, price creates a 15-minute bullish fair value gap. At this point, we are almost always going to be looking for buys in scenarios like this. The important detail here is the third candle does not violate the high of the expansion candle, which is candle number two. That means that structure remains intact. Because of this, price is primed to trade back into the fair value gap before continuing higher. This allows us to place a sell limit at the start of the gap.
Now, let's compare that with another example. Here, the third candle actually closed above the high of the expansion candle. When this happens, structure changes. Instead of priming price for a retracement back into the gap, the third candle signals continued expansion. And that's why price runs away without ever returning to the gap. You can see through the very next fair value gap that it creates, price does not close above the high and signals a retracement. Which is why the next bullish fair value gap was printed actually got retested before. Understanding this simple piece of logic can completely change how you view fair value gaps.
To summarize, fair value gaps are one of the most powerful concepts in smart money trading. But their true usefulness isn't behind the patterns themselves. It's what they reveal about: number one, market imbalance. Number two, intentions behind institutional orders. And three, the timing of the market. Once you stop viewing fair value gaps as just another entry model and start viewing them as a way to read price intention, then the market starts to make a lot more sense. And when you combine them with liquidity, time, and market structure, they become an incredibly powerful tool.
So, if you enjoyed the video or you have gained some knowledge on how to use fair value gaps for your own trading, then do me a favor, smash up the subscribe button and turn on the bell notification so that you get alerted when we upload a brand new video and comment down below FVG's so that I know that you guys here enjoyed this video here and will start applying it on your charts. All right, happy trading and I'll see you in the next.