The "Fair Value Gap" (FVG) pattern in forex is a concept derived from institutional trading theory, often associated with the work of traders who analyze inefficiencies in the price movement on a chart. It describes a gap that occurs when there is an imbalance between buyers and sellers, leading to a swift movement in price that leaves an area on the chart where few or no trades have occurred. This gap often indicates that the price did not fully "trade" at fair value during the initial move, leaving room for potential retracement to that area as the market seeks to fill the imbalance and achieve equilibrium.

Key Characteristics of the Fair Value Gap Pattern

1. Formation of the Gap:

   • The Fair Value Gap usually forms in highly volatile price movements, where a large imbalance between buy and sell orders creates a sudden directional move, leaving a visible gap on lower time frames.
   • It often appears in a series of three candles, where the middle candle has an unusually long wick or body, creating a gap relative to the preceding and following candles.

2. Price Imbalance and Market Inefficiency:

   • This pattern occurs due to an "inefficiency" in the market where the price fails to fully absorb buy or sell orders. As a result, the price may retrace to the gap area, as the market tends to seek equilibrium.
   • Institutional traders often monitor these areas as high-probability levels for price retracement or potential entry points.

3. Trading Strategy:

   • Entry: When a Fair Value Gap is identified, traders often wait for the price to retrace back into the gap area. If the price revisits this zone, it can serve as a potential entry point in the direction of the original movement.
   • Directional Bias: The gap generally aligns with a continuation of the prevailing trend, meaning if the price quickly moved upward creating a gap, a trader might look for a buy opportunity if the price retraces to that gap area.
   • Stop Loss and Take Profit: Traders typically set a stop loss slightly beyond the gap zone and may aim for profit targets aligned with key support/resistance levels or significant swing highs/lows.

4. Time Frames:

   • Fair Value Gaps are often identified on lower time frames, where these gaps are more visible due to the increased granularity of data. However, the concept can also apply across various time frames, depending on the trading strategy.

5. Benefits and Considerations:

   • Increased Probability of Filling the Gap: Market prices often revisit these gaps, making it a relatively high-probability zone for entry.
   • Risk of Strong Trends: In strong trending markets, the price may not revisit the gap for some time or may continue without filling it entirely. Traders need to consider this when placing entries and setting risk management strategies.

Example of Fair Value Gap in Action

Suppose a strong upward movement in the EUR/USD pair on the 1-hour chart creates a Fair Value Gap. Traders might look for the price to revisit the gap, then enter a long position when the price reaches the zone, expecting the bullish momentum to continue. The gap area provides a structured entry point and a manageable risk level for placing a stop loss.

The Fair Value Gap pattern can be an effective tool for analyzing market dynamics and predicting potential retracement zones, especially when integrated with other price action strategies and technical indicators. It’s a pattern that reflects the market’s tendency to balance itself by filling areas of inefficiency.