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Fair Value Gap Basics
If you’re a price action trader, you might be familiar with a concept that has been making the rounds lately called the Fair Value Gap. In this article, we’re going to talk through the basics of what a Fair Value Gap is, show some examples of how to think about using it in your trading, as well as how to scan for it on the TrendSpider platform. Let’s dig in.
Understanding Fair Value Gap
Before we get into how to utilize the Fair Value Gap indicator in your trading, let’s first talk through what a Fair Value Gap is.
Fair Value Gaps are most commonly used amongst price action traders and are defined as instances in which there are inefficiencies, or imbalances, in the market. These ‘imbalances’ simply suggest that buying and selling are not equal.
Fair Value Gaps are created within a three-candle sequence and are commonly visualized on the chart as a large candle whose neighboring candles’ upper and lower wicks do not fully overlap the large candle.
The reason why a trader might be interested in where these Fair Value Gaps occur is simply that the imbalance created by them can become a magnet for price in the future.
The Fair Value Gap Indicator
Like any other indicator on the TrendSpider platform, the Fair Value Gap indicator can be added to your charts by selecting it within your indicators button. Once added, it will highlight all Fair Value Gaps on your chart with blue horizontal shaded areas, as is pictured in the image below.
Trading A Fair Value Gap
In the example pictured below, we see a high made that is then followed by a strong sell-off. The first large red candle after the high is where the Fair Value Gap is created. Price trades down, begins to make a bottom and then climbs back up to test the previous high that was made. As soon as the fair value gap is filled, price sells off again. This would be an example of price filling to the upside in order to clear out the imbalance made from the Fair Value Gap. Once the gap is filled, there is no longer an imbalance and price can continue in the direction it was headed previously and a secondary down move occurs.
In the example pictured below, we see the opposite of the above example. A Fair Value Gap is created due to strong buying pressure. Price trades up, begins to top out and then pulls back into the Fair Value Gap. This clears out the imbalance that was made from the move up, and almost immediately after the gap is filled, price is able to continue quite higher.
Scanning Fair Value Gaps
Though it is not possible at this time to use the Fair Value Gap indicator in the scanner, it is still possible to scan for Fair Value Gaps using price action criteria. As we defined earlier in the blog, Fair Value Gaps are formed via a three-candle sequence in which a large candle’s neighboring candles’ upper and lower wicks do not fully overlap the large candle. Add these customs scans to identify Fair Value Gaps as they form!
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Building A Fair Value Gap Scanner
In the instance of a Fair Value Gap being created due to large buying pressure, we would use the following criteria:
- Price.Low (last) is greater than Price.High (2 candles ago) – This defines the lack of overlap between candle wicks
- Price.Close (1 candle ago) is greater than Price.Open (1 candle ago) by at least ‘x %’ – This defines the large buying pressure
- Price.Close (1 candle ago) is greater than Price.High (2 candles ago) – This defines that the candle with the buying pressure closed above the high of the previous candle
In the instance of a Fair Value Gap being created due to large selling pressure, we would use the following criteria:
- Price.High (last) is less than Price.Low (2 candles ago) – This defines the lack of overlap between candle wicks
- Price.Close (1 candle ago) is less than Price.Open (1 candle ago) by at least ‘x %’ – This defines the large selling pressure
- Price.Close (1 candle ago) is less than Price.Low (2 candles ago) – This defines that the candle with the selling pressure closed below the low of the previous candle
The below image shows these parameters scripted into the TrendSpider scanner.
If you’re a current TrendSpider user, you’re welcome to subscribe to this shared Fair Value Gap Scanner. Do keep in mind that this scanner looks for Fair Value Gaps that were created both to the upside and the downside. If you’d like specific scanners for each direction, save the condition groups and create your own! Additionally, feel free to create your own copy and adjust the parameters as you see fit.
If you prefer to learn via video tutorials, we’re happy to offer a video accompaniment to this blog!
So there you have it, folks. Some basic ways to be thinking about how to utilize The Fair Value Gap in your technical analysis and within the TrendSpider platform. We hope you found this helpful and we’d love to hear how you’re using this indicator! Feel free to reach out to us in chat with any questions or thoughts that you might have.
