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In trading, you may have heard about Fair Value Gap and Order Block, because understanding market dynamics and price movements is crucial. Two concepts that traders often use to analyze and predict these movements are Fair Value Gaps (FVG) and Order Blocks (OB). Let’s delve into what these terms mean and how you can leverage them to make informed trading decisions.
What is a Fair Value Gap?
A Fair Value Gap occurs when there is a significant difference between the market price of an asset and its perceived fair value. This gap typically arises due to imbalances between buyers and sellers, leading to rapid price movements that leave behind unfilled price levels on a chart.
Identifying Fair Value Gaps:
- Spot the Big Candlestick: Look for a substantial candlestick on your price chart with a significant body-to-wick ratio.
- Analyze Neighboring Candlesticks: Check the candlesticks immediately before and after the large one. They should not overlap entirely but create a gap between their wicks.
- Define the Gap: Draw the gap on your chart between the previous candlestick’s low and the following candlestick’s high in a bearish trend (reverse for a bullish trend).
Traders use FVGs to identify potential areas where the price may retrace to fill the gap before continuing its trend. This strategy can be particularly effective in markets prone to frequent imbalances, such as forex or stocks.
What is an Order Block?
An Order Block is a consolidation area on a chart where significant buying or selling has taken place, usually by institutional traders. These blocks are identified by clusters of orders that create strong support or resistance levels. When the price returns to these levels, it often reacts due to the presence of unfilled orders.
Characteristics of Order Blocks:
- Volume Spike: A noticeable increase in trading volume during the formation of the block.
- Price Rejection: After a strong directional move, the price retraces to the Order Block but is rejected by participants in the previous move.
- Support or Resistance: These areas often act as future support or resistance levels.
Traders utilize Order Blocks to predict where the price might reverse or continue its trend, offering high-probability entry signals based on historical price action.
Trading Strategies leveraging Fair Value Gap and Order Block
Combining FVG and OB:
- Market Structure Break: Look for a break in the market structure where the price moves significantly through a support or resistance level.
- Imbalance Identification: Identify the imbalance area created after the break, which represents the Fair Value Gap.
- Order Block Intersection: Locate the Order Block within this imbalance area for a potential high-probability entry point.
For instance, in a downward breakout, you would look for a Bearish Order Block and a gap created by the trend break, providing a strategic entry point for short positions. Conversely, in an upward trend reversal, identify a Bullish Order Block within the imbalance area for long positions.
This combination of FVG and OB can give traders a clear and specific entry point, enhancing their trading strategy by capitalizing on market inefficiencies and imbalances.