Fair Value Gaps (FVGs) are three-candle price imbalances where institutional orders moved price so aggressively that no two-way auction occurred. They represent unfinished business in the order book โ and price has a statistical tendency to return to these zones.
FVG Formation Mechanics
An FVG forms when the wick of candle 1 and the wick of candle 3 don't overlap. The gap between them is the Fair Value Gap. The middle candle (candle 2) is the displacement candle โ it represents the moment of aggressive institutional order flow.
For a bullish FVG: the gap forms between the high of candle 1 and the low of candle 3 during an upward move. For a bearish FVG: the gap forms between the low of candle 1 and the high of candle 3 during a downward move.
Why FVGs Get Filled
The reason is rooted in market microstructure. When price moves too fast in one direction, it creates an inefficiency โ a price range where buyers and sellers never properly matched. Market-making algorithms are designed to seek efficiency, and institutional order flow gravitates back to these zones to rebalance. Studies show that approximately 70-80% of FVGs on the 1H timeframe and above get at least partially filled within 20 candles.
The 5-Point FVG Quality Filter
1. HTF Alignment: The FVG must align with the higher-timeframe bias. 2. Displacement Strength: The middle candle should have a large body relative to recent candles. 3. Unmitigated: The gap hasn't been previously tested. 4. Confluence: The FVG overlaps with an order block or key level. 5. Session Context: Formed during high-volume trading sessions (London/NY for forex).
Entry, Stop, and Target
Enter at the 50% mark of the FVG (the midpoint between the high and low of the gap). Stop loss goes beyond the entire gap โ if the full gap gets swept, the thesis is invalidated. Target the next significant liquidity pool or structure level. This setup typically gives 1:2 to 1:3 risk-to-reward.