Skip to main content

6 - Evaluating Fair Value Gaps (FVG)

6.1 - Advanced Analysis of Fair Value Gaps​

Fair Value Gaps (FVG) are key indicators in financial trading and analysis, offering insights into market behavior and potential price movements. Their evaluation is enhanced by understanding their relationship with higher timeframe gaps, proximity to liquidity pools, and their history of being filled.

  1. Interplay with Higher Timeframe FVGs: The significance of an FVG increases substantially when it overlaps with a fair value gap on a higher timeframe. This overlap suggests a stronger likelihood of a pronounced price reaction at this point, compared to an isolated FVG. The alignment with a higher timeframe gap thus elevates its importance, making it a more influential factor for market analysts and traders.

  2. Proximity to Liquidity Pools: An FVG near a liquidity pool is often seen as a more potent market signal. Liquidity pools, being areas of concentrated orders, have the capacity to significantly sway price movements. Therefore, an FVG in close proximity to such pools is considered a more critical indicator of potential market shifts.

  3. Strength Post-Liquidity Grab: An FVG formed subsequent to a liquidity grab (a rapid price move beyond a key level, often a liquidity void) is typically regarded as a stronger indicator than one created in the absence of such an event. This rapid movement, potentially triggering stop losses and a flurry of trading activity, can signify a significant market shift or acceleration. The subsequent formation of an FVG in this context may reflect a consequential market realignment, suggesting that the preceding liquidity event (the move through the void) was instrumental in establishing new price levels or value perceptions in the market.

  4. Market Structure Shift: An FVG that breaches a market structure or causes a shift in the market structure is more likely to affect price action and elicit a response.

  5. Reaction to FVG: The initial FVG that forms following a significant response to another FVG is considered a powerful FVG, which may trigger a reaction from price action upon revisitation.

note

It's crucial to note that an FVG that has been filled in the past loses its relevance for future consideration. Once the price action has filled half the fair value gap, it diminishes its utility as an indicator. This aspect is essential for maintaining accuracy in market analysis, as relying on previously filled gaps can lead to misguided conclusions about market trends.

6.2 - Strategic Trading with LG, FVG, and MSS Analysis​

AbbreviationMeaning
LGLiquidity Grab
FVGFair Value Gap
MSSMarket Structure Shift

  1. Identify a Major LG: Start by pinpointing a significant LG in the market. This serves as your initial cue for potential trading opportunities.

  2. Assess FVG Disrespect Post-LG: After the LG, observe the price action in relation to a nearby, clear FVG. If the price fills this FVG and continues in its original direction, indicating a disregard for the FVG, take note. This suggests strong momentum in the direction of the fill and sets the stage for the next step.

  3. Confirm with MSS: Before finalizing your trading bias, confirm the potential shift in market structure. Look for evidence of an MSS that aligns with the direction indicated by the FVG disrespect. This confirmation is crucial to validate your trade idea.

  4. Formulate Trading Bias: Based on the above analysis:

    • Consider a long position if the LG is downward, the FVG is disrespected upwards, and MSS confirms an uptrend.
    • Consider a short position if the LG is upward, the FVG is disrespected downwards, and MSS confirms a downtrend.

  5. Trade Execution and Risk Management: Proceed with your trade idea while strictly adhering to your risk management protocols. Set appropriate stop-loss orders and define your risk tolerance per trade.

This guide emphasizes sequential analysis of LG, FVG, and MSS to inform trading decisions. It's important to remember that market conditions can vary, and flexibility in application, along with continuous market analysis, is key to successful trading.

6.3 - Extreme Price Inefficiency (EPI)​

6.3.1 - Defining Extreme Price Inefficiency (EPI)​

  • Extreme Price Inefficiency (EPI): This phenomenon occurs in financial markets when there is a pronounced, unidirectional movement in prices, characterized by an absence of counteracting candles or significant pullbacks. This aggressive trend often leads to the creation of several fair value gaps (FVGs), indicating substantial deviations from what is considered 'fair' or intrinsic value.

  • EPI Zone: This term refers to a specific segment in the market where prices have either surged upwards or plummeted sharply with minimal or no significant opposing candle formations. This indicates a strong, unilateral price movement. The mid-point of the EPI zone often serves as a key horizontal reference line on charts, as price action frequently shows reactions from this line, indicating potential areas of market interest or reversal points.

  • EPI Block: Defined as the area that includes the last significant opposing candle before the start of an EPI. This block is crucial for traders as it provides a benchmark to identify the commencement of the EPI, serving as a reference for potential market entry or exit points.

6.3.2 - Key Observations and Strategies​

  • Market Behavior Post-EPI: After an EPI event, markets typically exhibit a retracement or pullback phase. This phase is often characterized by a movement to 'fill' the inefficiencies created during the EPI, signifying a market correction or equilibrium-seeking behavior. Notably, this pullback is frequently preceded by the market reaching a significant level of interest or after capturing liquidity beyond a key threshold. Such a pattern becomes more evident when a deceleration in price movement and subsequent reversal is observed.

  • Strategic Implications: Identifying an EPI can unveil substantial trading opportunities, particularly during the market's pullback phase, as it attempts to correct the extreme inefficiency. Traders should craft strategies to leverage potential profits during this phase. It's crucial to employ a well-thought-out strategy and an effective entry model when using EPI in trading. Opportunities may arise both during the market's correction phase, as it fills the inefficiency, and after the market has reestablished a more balanced state post-inefficiency. Understanding the nuances of EPI and its implications on market dynamics can be a significant advantage for strategic trading.

6.4 - Drawing on Liquidity (DoL) & Determining Directional Bias with Fair Value Gaps (FVG)​

In the context of high timeframe analysis, you can utilize the following methodologies to establish your market bias and potentially identify high-probability trading opportunities on shorter timeframes:

  1. Fair Value Gaps (FVG) that break market structure are expected to hold when price action revisits them. The price should bounce from these imbalances. If a specific FVG that broke the market structure fails to hold as support or resistance, it is theorized that all subsequent FVGs beneath it will also fail until the price reaches the next significant liquidity pool found at equivalent highs/lows or pivot points.

  2. A strong FVG typically leads to the creation of more FVGs, suggesting a continuation of market momentum and validation of the new price range.

  3. Candlestick formations that break through and displace beyond previous highs or lows should continue in their trajectory without retesting the FVGs created before their formations. If they do revisit these FVGs after the displacement, it is likely that these imbalances will not hold.