Fair Value Gap: An Essen al Tool for Technical Traders

Fair value gaps are price gaps that occur when there is a significant difference between the closing
price of one trading and the opening price of the next, with minimal or no trading in between.

If you’ve ever wondered about those sudden gaps in price on a chart and what they mean, you’re
not alone. This ar cle will show you what is a fair value gap, what they signify, and how to leverage
them to enhance your trading decisions!
Key Takeaways

 Fair Value Gaps occur when there's a significant price difference between the close of one
period and the opening of the next, signaling market inefficiencies.
 Bullish gaps indicate poten al upward momentum, while bearish gaps suggest poten al
downward pressure.
 Use fair value gaps to pinpoint entry and exit points, manage risk, and confirm trend
strength, enhancing trading decisions.
Key Takeaways
 Fair Value Gaps occur when there's a significant price difference between the close of one
period and the opening of the next, signaling market inefficiencies.
 Bullish gaps indicate poten al upward momentum, while bearish gaps suggest poten al
downward pressure.
 Use fair value gaps to pinpoint entry and exit points, manage risk, and confirm trend
strength, enhancing trading decisions.
What Is a Fair Value Gap (FVG)?

A fair value gap is a price gap that occurs when there's a no ceable difference between the closing
price of one trading period and the opening price of the next.

Essen ally, they show moments when the market hasn't had enough me to digest informa on,
leading to abrupt price changes. Understanding the meaning of the fair value gap can be crucial for
making informed trading decisions.

Structure of a Fair Value Gap on a Chart

Here’s how how to iden fy fair value gap on a chart:
Let's say that the gap occurs due to a significant upward price movement.
 Ini al Price Movement: First, you'll see a sharp rise in the closing price of the ini al trading
period.
 Gap: If the opening price of the next period is higher than the closing price of the previous
period, the chart shows a blank space between the two prices.
 Next Trading Period (Con nua on or Correc on):

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 o Con nua on: A er the gap, the price may con nue in the direc on of the gap,
indica ng strong momentum.
o Correc on: Alterna vely, the price may retrace to fill the gap, moving back towards
the closing price of the previous period.
What Causes a Fair Value Gap?

Several factors can cause a fair value gap, including:

Economic News and Announcements
Major economic events, such as interest rate
decisions, employment reports, and GDP releases, can
cause significant market movements.
When these announcements occur outside of regular
trading hours, they can lead to a fair value gap as the
market reacts to the new informa on once trading
resumes.
Earnings Reports
Corporate earnings reports can also trigger fair value gap trading.
Posi ve or nega ve earnings surprises o en lead to sharp price movements when the market
opens, crea ng a gap between the previous closing price and the new opening price.
Market Sen ment
Sudden shi s in market sen ment, driven by geopoli cal events, natural disasters, or changes in
investor confidence, can cause rapid price movements that result in fair value gaps.

These events can lead to panic buying or selling, crea ng gaps as the market adjusts to the new
sen ment.

Supply and Demand Imbalances

Significant imbalances between supply and demand can cause fair value gaps.
For example, a large ins tu onal order placed outside of regular trading hours can create a gap as
the market opens and prices adjust to reflect the new supply or demand levels.

Types of Fair Value Gaps

Fair value gaps can be categorized based on their direc on and market context.
Bearish Fair Value Gaps

A bearish Fair Value Gap indicator occurs when there is a gap between the lowest point of the
wick on the first candles ck and the highest point of the wick on the third candles ck.

This gap typically forms within the body of the middle candles ck.

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What is crucial is that a gap has formed within the middle candles ck due to the lack of connec on
between the wicks of the first and third candles cks, indica ng poten al downward pressure.

Bearish fair value gaps are caused by factors such as

nega ve economic news, disappoin ng earnings
reports, or sudden shi s in market sen ment toward
pessimism.
Bullish Fair Value Gaps

A bullish Fair Value Gap indicator forms when there is

a gap between the highest point of the wick on the first
candles ck and the lowest point of the wick on
the third candles ck.
Similar to the bearish FVG, the exact direc on of each
candles ck is not the main focus. What ma ers most is
the presence of a gap within the middle candles ck
where the wicks of the first and third candles cks do not meet.
This gap signifies poten al upward momentum and buying opportuni es.

Bullish fair value gaps are typically triggered by posi ve

economic news, be er-than-expected earnings reports, or a
sudden shi in investor sen ment towards op mism.

Using Fair Value Gaps in Trading

Fair value gaps provide ac onable insights for traders:
Entry and Exit Points: Traders use fair value gaps to iden fy
poten al entry points when the gap is expected to be filled.
Similarly, exit points can be set once the gap is closed.
Risk Management: Proper posi on sizing and stop-loss
orders are crucial when trading fair value gaps to mi gate
poten al risks.
 Prac cal Examples: For instance, if a stock gaps up significantly on posi ve news, a trader
might wait for the price to retrace to fill the gap before entering a long posi on, an cipa ng
a con nua on of the uptrend.
The Role of Fair Value Gaps in Technical Analysis
Fair value gaps play a crucial role in technical analysis by highligh ng market inefficiencies and
providing traders with ac onable insights.
Iden fying fair value gaps helps traders an cipate price movements.

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For example, a bullish gap up might retrace to fill the gap before con nuing upward, while a bearish
gap down might briefly recover to fill the gap before resuming its decline.
These gaps indicate poten al entry and exit points for traders.

Fair value gaps also confirm trend strength. In an uptrend, bullish gaps suggest con nued upward
momentum, while in a downtrend, bearish gaps indicate sustained downward pressure.

Fair Value Gap vs. Order Block

A fair value gap and an order block serve different func ons in trading, but both provide key insights
into market movements.
A fair value gap represents a price gap between the closing price of one period and the opening
price of the next, indica ng a temporary market inefficiency.
On the other hand, an order block refers to a price zone where large ins tu onal orders, such as
those placed by banks or hedge funds, have been executed.
These zones o en act as significant support or resistance levels, as the price tends to react strongly
when revisi ng them.
While fair value gap trading focuses on gaps that may get filled, order block trading revolves around
key price zones where large players have entered the market, offering high-probability trading
opportuni es based on those levels.

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Fair Value Gaps vs. Imbalances
While both fair value gaps (FVGs) and market imbalances highlight inefficiencies in the market,
they differ in how they appear and impact price ac on.

A market imbalance occurs when there is a significant difference between buying and selling
pressure, o en leading to one-sided price movement.

Unlike FVGs, imbalances do not always leave visible gaps on the chart but can s ll indicate areas
where price may revisit to rebalance supply and demand.

Key differences between fair value gaps and imbalances:

 Visibility: FVGs are visible gaps on the chart, while imbalances may appear as extended price
movements.
 Cause: Imbalances are o en driven by large ins tu onal orders, whereas FVGs result from
rapid price movement with li le trading in between.
 Trading Approach: Traders use FVGs to an cipate price retracements, while imbalances help
iden fy areas where market par cipants may step in to restore equilibrium.
Using a fair value gap indicator can help traders spot poten al trading opportuni es, but
understanding market imbalances alongside FVGs provides a more complete view of price ac on.
Fair Value Gaps vs. Other Price Gaps
Understanding the differences between fair value gaps and other types of price gaps is crucial.
Fair Value Gaps vs. Common Gaps

Fair Value Gaps typically indicate poten al areas where the market will retrace to fill the gap,
reflec ng underlying market inefficiencies.

Whereas Common Gaps o en occur in non-trending markets and are usually filled quickly without
significant trading opportuni es.
Fair Value Gaps vs. Breakaway Gaps

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Fair Value Gaps occur during regular trading and suggest a poten al retracement to fill the gap. On
the other hand, Breakaway Gaps happen at the beginning of a new trend, o en due to a breakout
from a consolida on pa ern, and are less likely to be filled immediately.
Fair Value Gaps vs. Exhaus on Gaps
Fair Value Gaps indicate a temporary market inefficiency that will likely be corrected.

However, Exhaus on Gaps occur near the end of a significant price move, signaling a poten al
reversal or the end of the current trend.

Algorithmic Trading and Fair Value Gaps

Algorithmic trading, also known as algo trading, uses automated systems to iden fy and execute
trades based on predefined criteria, such as price gaps, volume, and technical indicators.
Trading algorithms are programmed to scan large amounts of market data in real- me to detect fair
value gaps across different meframes. These algorithms use a variety of techniques to spot gaps,
including:
 Pa ern Recogni on: Iden fying gap forma ons based on price ac on and historical data.
 Fair Value Gap Indicators: Specialized indicators highlight gaps on charts, making it easier
for algorithms to act upon them.

 Volume Analysis: Algorithms analyze trading volume to confirm whether a gap is likely to be
filled or con nue in the trend direc on.
 Momentum Tracking: Monitoring price momentum to determine if a fair value gap presents
a trading opportunity.
By using these methods, algorithmic trading systems can iden fy fair value gaps more efficiently
than manual analysis, allowing for quicker decision-making.
How to Trade Fair Value Gaps Effec vely
Trading fair value gaps effec vely requires understanding the market context, se ng proper risk
management rules, and recognizing when a gap is likely to be filled.
Traders o en wait for price retracements into the gap to open posi ons.
 For bullish gaps, this can mean wai ng for a price dip a er a gap-up to enter a long posi on.

 For bearish gaps, traders may look for price retracements upward into the gap before
ini a ng a short posi on.

Indicators like volume, trend strength, and candles ck pa erns can help confirm trade setups.
Fair Value Gaps in Different Timeframes
When it comes to fair value gap trading, choosing the right meframe is crucial. Fair value gaps can
appear on any chart, whether you're trading stocks, forex, or cryptocurrencies. However, different
meframes can provide different insights into how the market reacts to these gaps.

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Short-Term Timeframes (Intraday Trading)
For traders who focus on short-term moves, such as day traders and scalpers, using smaller
meframes like 1-minute, 5-minute, or 15-minute charts can help spot fair value gaps that may fill
quickly.
These gaps are o en caused by sudden news or market vola lity.

Benefits of short-term trading fair value gaps:

 Quick trading opportuni es based on gap fills.
 Smaller stop-loss levels for be er risk management.
 Frequent trading opportuni es throughout the day.
However, short-term gaps can some mes be less reliable due to market noise and unpredictable
price ac on. That's why traders o en use a fair value gap indicator to confirm poten al trade
setups.
Medium-Term Timeframes (Swing Trading)

If you're a swing trader looking for trades that last a few days to weeks, medium-term meframes
like the 1-hour or 4-hour charts are ideal.

Fair value gaps on these charts tend to reflect stronger market movements, offering be er trade
reliability.

Why medium-term meframes are useful for fair value gap trading:
 Gaps are more meaningful and easier to analyze.
 Market condi ons have more me to stabilize.
 Provides a balance between frequent opportuni es and reliable setups.

Traders o en use technical tools like moving averages and momentum indicators alongside fair
value gap indicators to strengthen their trading decisions.

Long-Term Timeframes (Posi on Trading)

For long-term traders or investors, fair value gaps on daily, weekly, or monthly charts can provide
insights into larger market trends. These gaps usually occur due to significant economic events or
major shi s in market sen ment.
Advantages of long-term fair value gap analysis:
 Provides a clear picture of market direc on.
 Helps iden fy key support and resistance zones.
 Suitable for traders who prefer lower trade frequency and higher accuracy.

While fair value gaps on higher meframes take longer to fill, they o en align with strong trends,
making them valuable for strategic trading decisions.

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Choosing the Right Timeframe for Fair Value Gaps
The best meframe for fair value gap trading depends on your trading style, risk tolerance, and
market condi ons.

Day traders may prefer shorter meframes for quick entries, while swing traders and investors might
focus on longer meframes for more reliable setups.

Regardless of the meframe you choose, using a fair value gap indicator can help you accurately
iden fy gaps and improve your overall trading strategy.

Advantages and Limita ons of Using Fair Value Gaps

Fair Value gaps have several advantages as well as limita ons:
Advantages
 Improved Market Timing: Fair value gaps help traders iden fy op mal entry and exit points.
 Enhanced Decision-Making: Provides clear signals based on market inefficiencies.

 Poten al for Higher Profits: Effec ve use of fair value gaps can lead to profitable trading
opportuni es.
Limita ons
 Poten al for False Signals: Not all gaps will be filled, leading to possible false signals.
 Market Condi ons: The reliability of fair value gaps can vary depending on market
condi ons.
 Risk Management: Requires careful risk management to avoid significant losses.
Common Mistakes in Fair Value Gap Trading

New traders o en misunderstand or misuse fair value gap trading strategies. Here are the common
mistakes to avoid:
 Assuming all gaps will be filled: Not every gap will be retraced, and relying solely on gap fills
can lead to significant losses if the price moves further away from the gap.
 Ignoring the broader market context: Failing to consider factors such as major news events
or economic data releases that may cause the gap can result in poor trading decisions.
 Entering trades too early: Traders o en enter posi ons before confirming that the gap will
be filled, which can lead to premature stop-outs or losses.
 Over-leveraging posi ons: Overes ma ng the likelihood of a gap being filled without
proper risk management can result in larger-than-expected losses.
Conclusion
Fair value gaps are price gaps that highlight market inefficiencies and poten al trading
opportuni es.By iden fying these gaps, traders can an cipate price movements and confirm trends,
making more informed trading decisions.

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 1. What does FVG mean in Trading ?

FVG stands for Fair Value Gap, indica ng a price gap on a chart where there is a significant difference
between the closing price of one period and the opening price of the next, with minimal trading in
between.

2. What is the difference between a bullish fait value gap and a bearish fair value gap ?
Bullish Fair Value Gap: A gap between the highest point of the first candles ck's wick and the lowest
point of the third candles ck's wick, indica ng poten al upward momentum.
Bearish Fair Value Gap: A gap between the lowest point of the first candles ck's wick and the highest
point of the third candles ck's wick, indica ng poten al downward pressure.
3. What is the difference between order block and fair value gap ?
Order Block: A price range where large ins tu onal orders have been placed, ac ng as support or
resistance zones.

Fair Value Gap: A gap between the closing price of one period and the opening price of the next,
highligh ng market inefficiencies.

4. What is an example of a value Gap ?

A stock closes at $50 and opens at $55 the next day without trading in between, crea ng a $5 bullish
fair value gap, indica ng strong buying interest. Conversely, a close at $50 and an open at $45 would
create a $5 bearish fair value gap, indica ng strong selling pressure.
5. How do I iden fy a fair value on a chart ?
To iden fy fair value gaps, look for periods where there is a no ceable gap between the closing price
of one period and the opening price of the next, o en seen as a blank space on the chart.

These gaps typically occur a er significant news or market events that cause a rapid price change.

6. Do all fair value get filled ?

Not all fair value gaps get filled. While many gaps eventually retrace as the market seeks balance,
some gaps can indicate the start of a new trend and may not be filled for an extended period, if at
all.

What is Fair Value Gap and how to use it in trading?

Price ac on traders love them and smart money traders also can't get enough of them. In fact, there
are few price pa ern to that price reacts so strongly, offering a good risk/reward ra on. So today,
let's take a look at how fair value gaps are created, how to recognize them and most importantly -
how to trade fair value gaps.

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What is the Fair Value Gap?

Fair Value Gaps are price jumps caused by imbalanced buying and selling pressures. These gaps are
some mes called Price Value Gaps, or Singles, and you may also encounter the term imbalance. In
this ar cle, we will use the term Fair Value Gap (also referred to as FVG).

Fair Value Gap indicates a market situa on where the supply of buyers is significantly higher or lower
than the demand of sellers. This can cause the price of an instrument to move quickly towards higher
supply or lower demand. The Fair Value Gap then shows the point in the chart where this rapid price
movement occurred.

FVGs can be seen on charts as large candles that are not completely covered by the wicks of adjacent
candles. The FVG forma on consists of three candles and there are bullish and bearish FVGs. In
simplified terms, we can illustrate them as follows:

Fair Value Gaps represent a kind of anomaly, an imbalance in the market, a situa on where the price
has deviated from fair value. And since the market tends to return to fair value, it is possible to take
advantage of this fact.

Price ac on traders rely on FVG to:

 The likelihood that the market will bounce back to fill the FVG before con nuing in the
direc on it was originally heading.
 Once the FVG is filled, they are coun ng on the trend to con nue in the direc on of the
covered gap.

When does the Fair Value Gap form?

The situa on where the market price deviates from the normal value, thus crea ng a Fair
Value Gap, is not accidental. Therefore, below we describe the scenarios in which a FVG can
be expected to form.

 Important events
Major news that causes a sudden change in market sen ment can lead to a FVG. Such news
is, for example, an unexpected increase in interest rates. This increase may then trigger a
spike in the domes c currency, which will result in an FVG. There are many events that can
cause significant market movement. These are not only macroeconomic data, but also
poli cal news, such as informa on about the outbreak of war, geographical events such as
earthquakes, etc.

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  The publica on of corporate economic results
If a company's results come as a significant surprise, there will be a rapid price movement.
This may then be reflected in the price of the stock index of which the company is a part,
which may then form the FVG.

 Large ins tu onal deals

Large ins tu onal trades can also lead to FVGs. For example, if a large hedge fund buys a
large number of shares, this can cause a gap in the market. Or if a central bank starts
intervening in the market and buying (or selling) domes c currency, etc.

 How to Trade the Fair Value Gap

Because these gaps represent an imbalance, Fair Value Gaps o en fill up. We can use this
knowledge to accurately determine the price level where we want to enter a trade.

 Filling the gap

With this strategy, it is important to determine what the current trend is. This should be
determined on a higher me frame, such as weekly, daily, or H4. A healthy uptrend produces
a higher high (HH) and higher low (HL), while a downtrend produces a lower high (LH) and
lower low (LL).
If the HH breaks in an uptrend or the LL breaks in a downtrend, a break of structure (BOS) is
formed and the trend is likely to con nue.
If a break of HL occurs in an uptrend to the downside, a change of character (CHOCH) occurs
and the chance that the uptrend could reverse and start to decline increases. In a downtrend,
the analogy is then reversed, i.e. when a break of the lower high (LH) to the upside increases
the chance that the market decline could stop and the market could start to rise. An example
is shown in Figure 2.

It is important to note the points where the BOS or CHOCH break occurs. If the break is accompanied
by the forma on of a FVG, then a strong impulsive move has occurred and the price is likely to
con nue in the direc on of the FVG that formed the break. In such a case, a pa ent trader will wait

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for the moment when the broken line is returned (and therefore the gap that was formed on it is
filled), and then consider entering in the direc on of the filled gap.

If the break occurs such that the break line is not inside the gap, the situa on is less reliable for the
gap to act as support (uptrend) or resistance (downtrend). An example of a strong break with FVG
and a less reliable break without FVG in a bullish trend is shown in the next figure.

The idea is that the break of support or resistance should be inside the FVG, which has a visibly
longer middle candle than the surrounding candles. These breaks indicate that they were made with
impulsive force and tend to be more reliable. Therefore, it is preferable to focus on these situa ons.

We will show this prac cally in the following example, where we have the DJ30 instrument on the
H4 chart.

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We have iden fied a growing trend in which several FVGs have been formed. In situa on 3 and 4,
an FVG has been formed with the forma on of a BOS structure break in an uptrend. These are
situa ons where it would be possible to enter a long trade in accordance with the previous theory.
Then in situa ons 1, 2 and 5 the FVG was formed inside the uptrend structure.

We can also see that the gap was not always completely filled, so in this case the trade would not
have occurred. Gaps 1, 4 and 5 were later filled (see arrow). Then in situa on 3 there was a par al
filling. In the case of the gap created in point 2, there was no gap filling at all.

You may also no ce that when a gap is filled, it may also be 'overshot'. This is because gaps serve as
indicators where liquidity is collected in the form of pending stop losses. Liquidity collec on theory
teaches that smart money will first collect this liquidity and only then will the market turn.

In the next chart we have examples with bullish and bearish FVG, a change in market character
(CHOCH) and a BOS with a downtrend.

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At FVG 1, the BOS is an uptrend, which was later tested and the price bounced up. At FVG 3, the
previous higher low (HL) was broken, so there was a change in market character (CHOCH) which was
confirmed by the bearish FVG, which is a strong confirma on. This was later filled and a short could
be entered. Candle 4 offered a BOS (break of the lower low, LL) again with an FVG which was later
retested and it would be possible to enter short again.

And what about candle 5? This candle did produce an FVG, but this FVG did not break the previous
low. The low was indeed broken by a long candle, but the following candle closed above it. So, there
was a breakout here, but no FVG (recall Figure 4). Thus, there was no BOS with a valid FVG, but a
false break.

Then at point 6, there is again a breakout with a change in market character (CHOCH) as the previous
lower high was broken to the upside. It would therefore be a possible long entry. Then the gap from
candle 2 was filled and price then reversed down.

The gaps on candle 7 were not filled. Then at 8, the downtrend was confirmed by a lower high and
lower low, and since there was a BOS of the lower low with the help of FVG, on retest, a short entry
would be valid.

What are the advantages and disadvantages of FVG?

Advantages:

 If a trader can trade FVG, he can achieve a good risk/reward ra o.

 FVG can be easily iden fied in a chart.
 This strategy can be used on a wide range of assets, including stocks, commodi es and
currencies.
 It works on all me frames.

Disadvantages:

 Some mes gaps don't fill and some mes can get "overshot”. This can cause uncertainty.
 FVGs represent a form of liquidity collected by smart money. Therefore, some mes the price
can go far against the direc on of the gap.

More ps for trading with FVG

 Use a combina on of indicators: when trading FVG it can be useful to use a combina on of
indicators. For example, our Purple Gap indicator is an important tool.
 Use stop loses: When trading FVG, don't forget to use stop loses. This will help protect your
profits and limit your losses.
 Wait for Confirma on: Before entering a trade, it is important to wait for confirma on that
the market will indeed con nue in the direc on of the gap a er the FVG is filled. This can be
done by looking for a reversal bullish or bearish candle (such as engulf) on a lower meframe
a er the gap is filled, or you can use our Purple Strike indicator.
 Timing.
 Liquidity Pick: If the gap is close to an area where liquidity could be picked (for example, FVG
is near the previous day's high or low), wait for liquidity to be picked. Only then enter the
trade.

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Smart Money Strategy and trading liquidity

 Why is liquidity important?

Many traders don't realize that the price of the instrument they follow so closely doesn't move
according to the indicators. Indicators are lagged and more or less serve the purpose of allowing the
trader to sort the market data into some sort of aggregate, which he then works with. The impetus
for the price movement is the liquidity represented by pending orders. Such orders are, for example,
stop losses.

Have you ever had the market pick you out on a stop loss? Then at that very moment, you became
liquidity for someone else. If you want to increase your chances of success in trading, you should
learn to look for places in the market where.

Where to look for liquidity levels?

On various price forma ons (for example, double top), trend lines, horizontal supports and
resistances, Price Value Gaps, previous swing high and low, etc., here we can find levels where
liquidity can be looked for.

The principle is that traders usually look for these forma ons because they are widely known, and
place their pending orders - no ma er if it is a stop loss or another order (e.g. take profit, buy stop,
etc.) - at the levels to which these forma ons "a ract" them. Since they all know the same principles,
the order volume accumulates at similar levels. However, for the market (or the big players) all these
orders represent liquidity and therefore they will try to push the price of the instrument towards
them.

In a chart, the liquidity picking will manifest itself by the fact that at a given level (which is easy for
traders to read and therefore enter the trade), a certain "overshoot" of that level will first occur, i.e.
the price will make a breakthrough. This gives the impression that the price starts to move in the
direc on of the breakout. However, the price then pulls back and con nues in the opposite
direc on. O en such a situa on is seen on the chart as a false break. These false breaks indicate
that liquidity has been taken out and so the price can now go in the opposite direc on.

Let's explain this with a simple example:

At point A, a peak is formed, so the trader draws a horizontal line from this level, which represents
the resistance. At point B, on the other hand, there is a swing low, which represents support.

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At point 1, the resistance has been broken. Here, stop losses are selected by those traders who
speculate short and/or buy stop orders by those traders who speculate on a break of resistance A
and expect an upward move for the break. Those who speculate long a er the break will place their
stop lots either below the B level or just below the A level.

These orders are then new liquidity for the market to pick up. Therefore, the market will reverse and
instead of going up, it will now head down. The return of the price back below the A level then
creates a false break at point 2 and a er this false break the price heads down.

At point 3, the situa on is analogous, only in reverse. First, a break of support occurs and this is due
to the fact that orders have been accumulated here again. This me, these are stop loses of those
traders who speculated long or sell stop orders of those traders who expected a break and assumed
that the price would head further down. A er these orders are selected, the price reverses, a false
break is created again and the price con nues in the opposite direc on.

Tip: If you iden fy a false break in the chart, it is usually a strong signal to enter a trade in the
opposite direc on.

This is - very simplis cally - the whole principle of liquidity selec on. In prac ce, of course, the
examples will not be so clear-cut, you need to learn to look for, levels where liquidity may be and
then wait pa ently for it to be selected. You enter the trade a er the liquidity is selected and the
price reversal is confirmed in some way (e.g. by an engulf candle, or Price Value Gap, etc.).

Where the most frequent liquidity withdrawals occur in the real market

High and low of the previous day, week, or month

We will show an example of liquidity selec on on the low of the previous day. In the picture, we
have the USDJPY pair on the H1 chart. At point A is the low of 11/14/2023, so it offers to plot
horizontal support. Traders then o en speculate that when the price approaches this low, it will then
bounce upwards. They put a stop loss below this support. The following day, this low was selected
when the US industrial infla on data was reported. This came out much be er than expected and
so it would be logical that the dollar should weaken. But the opposite happened.

The big players first pushed the dollar down a er the report was announced to pick up pending
orders that had accumulated below this support. A er collec ng these orders, the market reversed
and quickly headed up to collect addi onal liquidity, which was now represented by orders from
those traders who were convinced that USDJPY had to fall.

Thus, from a fundamental perspec ve, this intraday rise in the USDJPY pair was extremely illogical.
However, from a price ac on perspec ve according to SMC, the big players went for filling the Price
Value Gap that was created on 11/14/2023.

pg. 16 XS.com
USDJPY on H1 chart

Tip: The high and low of the previous day, week, and month tend to be levels that the market likes
to test. A er taking out liquidity at these levels, wait for the market to reverse and create a false
break of that level. Only then consider the trade. Confirma on to enter the trade can be on a lower
me frame, you can use for example a Price Value Gap, or an engulfing candle, pin bar, etc.

1.2 Horizontal support and resistance

Liquidity withdrawals occur not only on the previous day's high and low, but also on various swing
highs and lows, and they happen on all me frames.

pg. 17 XS.com
EURJPY on D1 chart

The picture shows EURJPY on the daily chart. A top was formed at point 1, which was tested and
slightly overcome at point 2, but the price then closed below this resistance. So a false break was
created. The liquidity above the resistance has been taken out.

At point 3, liquidity was then picked up more strongly. Traders who were wai ng for this situa on
were more confident because they saw that the top had already been tested, so they speculated
that this resistance would work again. It did indeed work, but only a er most traders had been
kicked out of the market. These were those who had buy stop orders above that resistance because
they speculated long a er the resistance broke, or stop loss orders because they speculated short
at that resistance.

1.3 Trend lines

Trend lines (TL) are another popular place to withdraw liquidity. The logic is that traders place stop
loss orders just above a downtrend line, or just below an uptrend line. In prac ce, it then looks like
this:

EURJPY on D1 chart

Points 1 and 2 are enough to draw a trend line. There was a slight break of this TL at point 3, but it
was nothing major. Then at point 4, the break of the TL was more fundamental as the price closed
below the TL. Thus, there was a stop loss collec on that was placed below the TL.

What is going on in the trader's head at this point? Mostly, he will think that this strong move and
break TL means that the uptrend is over and will therefore start specula ng short. And because he
wants to catch this move right at the start to get the best price, he quickly enters the trade short

pg. 18 XS.com
without wai ng for a retest or some other form of confirma on. He then places a stop loss order
above the price. However, these SLs represent liquidity and therefore the price has gone back above
the TL.

There are many varia ons on the theme of picking liquidity. However, they always have one common
denominator, which is inducement.

Smart Money - liquidity inducement

In the context of liquidity collec on, the term inducement is used, which means "lure" or "trap".

From the examples above, you may have guessed what this is all about. When the market creates a
readable situa on, such as resistance, the trader thinks the price will turn there and enters the trade
short, pu ng the stop loss above the resistance.

O en, however, he will do this too soon under the fear that he might miss the opportunity
(technically known as FOMO (Fear of Missing Out). Price manipula on at these levels can also
contribute to FOMO - for example, the price starts to make small pullbacks, so the trader gets the
belief that the move will happen...etc. This trap will then a ract other traders. Once enough orders
accumulate above resistance, those will be picked first and then the real move will begin.

“ Inducement is therefore a situa on that will give the impression that the price will move in a
certain direc on. Once enough orders (which are liquidity) have been lured in, they will first be
picked. Only a er this manipula on will the actual movement occur.”

The following diagrams show us examples of different traps:

Examples of "inducements"

pg. 19 XS.com
Inducements can arise in different trends and at different price points

The basic types are shown in Figure above:

 Situa ons A and B are examples of situa ons where the trader thinks the trend is star ng to
turn, but a er manipula on, the market con nues in its original direc on.
 Situa on A shows a clear downtrend. As soon as the last lower high is broken so that the first
higher high is formed, the trader starts to think that a trend reversal (Change of Character)
is occurring and starts to speculate long. However, the stop losses that he places below the
first higher low (marked as "HL") serve as liquidity that the market will start to collect, and
therefore the price will start to fall in the direc on of the main trend.
 Situa on B shows an uptrend, when the first lower low is formed the trader starts to think
that a change in trend is occurring, so he enters short, placing the stop loss above the lower
high (marked as "LH"). This is then selected and the trend con nues upwards in the original
direc on.
 In situa ons C and D, a situa on will arise where the trader is convinced that the trend is
con nuing in the original direc on, only for the market to turn in the opposite direc on.
 In situa on C, a BOS (break of structure) occurs in the downtrend and a new lower low is
formed. This convinces the trader that the downtrend is gaining momentum. When a new
lower high is formed. traders place stop losses above this lower high (LH). A er liquidity is
collected the price con nues upwards.
 In the case of situa on D, this is analogous to an uptrend. Once the BOS occurs and a higher
high is formed, the trader is confident that the uptrend will con nue. He puts the stop loss
below the new higher low (HL). These orders are then selected and the market reverses.
 The above examples suggest that levels or pa erns that indicate where liquidity withdrawals
will occur tend to be more complex than mere false breaks on horizontal S-R zones. But if
you start to look at the market through this lens, you will gradually gain experience that will
open up a new dimension of trading.

How to trade liquidity

A. On a higher frame - weekly, daily or H4, mark the main price levels and iden fy what trend
is taking place (uptrend, downtrend, sideways).
B. Since you now know that liquidity trading works by having the price sort of overshoot a given
level, unlike the tradi onal plo ng of supports and resistances, which tend to be shown as
certain zones of a certain range, in the case of this concept, you just need to plot a simple
line that comes from the highest point (in the case of resistance) or the lowest point (in the
case of support).
C. Then wait for the price to jump over that level. This is a signal that the market is picking up
liquidity beyond that level.
D. The next step is that the price must go back down (below the resistance line or above the
support line). This will indicate that liquidity has been selected. This pullback must be valid,
i.e. the candle should close in that area. This close in that zone should be clearly visible (see
charts 5 and 6).
E. To enter, wait for confirma on on a lower meframe (e.g. Price Value Gap, engulf, pin bar,
etc.).
F. Since the liquidity withdrawal has already occurred, a ghter stop loss can be given which
will then allow for a more favorable RRR. This is the main advantage of the whole concept.

pg. 20 XS.com
Example:

In the picture we have the AUDCAD pair on the weekly chart. At point A a high has been formed, at
point C a low. At these points, we then draw a line that will mark the liquidity selec on limit. We
then wait for the price to "cross" these boundaries. The "overshoot" occurred at points B and D.

AUDCAD on the weekly chart

We then move to a lower meframe, in this case D1, where we wait for a form of entry confirma on.
In the case of the specula on at point B, it looked like this:

Price picked up liquidity through candle #1, and during the same day it came back below this
resistance, where this candle also closed. This close below the resistance level is dis nct, clearly
visible, and easily iden fiable, so it is valid (it would be invalid if the price closed above resistance,
at resistance, or just slightly below resistance, which would not be dis nctly clear).

Candle 1 also resembles a pin bar, which is a reversal forma on. Entering at the next candle
(indicated by the arrow) and with a stop loss above the high of the forma on and specula ng to the
nearest support, a trade would be created with an RRR of 1:5.

pg. 21 XS.com
AUDCAD on D1 chart, specula on short

The next chart shows an analogous situa on, this me in reverse.

AUDCAD on D1 chart, specula on long

At point D, the price broke through support. A er liquidity withdrawn, a bullish engulf was formed
(candle 1) and the price closed above the support. Again, we can see that the close above support
is significant, it is clearly visible and easily iden fiable. This is a strong signal. Entering on the next
candle and with a stop loss below the lowest price of the forma on, an RRR of 1:3.5 would be formed
to the nearest major top

pg. 22 XS.com
Smart Money Strategy and Trading with Order Blocks

The smart money strategy, which is hugely popular among advanced traders, follows the trail le
behind by the so-called big players in the market. One of these traces is a forma on known as an
order block. We will discuss how and why these blocks are formed in today's ar cle. At the same
me, we will show you the basics of an advanced trading strategy with the help of which you can
manage order blocks effec vely.

What is Order Block (OB)

Order Blocks (herea er referred to as "OBs") are groupings of orders at a specific price level that are
located throughout the price chart and on different me frames. Smart Money's trading strategy
works with these blocks and as such they represent a large volume of posi ons and cause impulsive
price movement. In other words, an order block in forex refers to specific price levels of supply or
demand at which major market par cipants have placed their orders and ini ated large moves.

For the purpose of trading OBs and iden fying them in the chart, the following defini on can be
used:

Bearish order block

 The last bullish candle made the highest high, before the next decline.
 Confirma on: A bearish order block is confirmed when it is followed by an impulsive move
that shows up on the chart as a Price Value Gap.

Bullish Order Block

 Defini on: The last bearish candle that has formed the lowest low before the following
upward movement.
 Confirma on: A bullish order block is confirmed when it is followed by an impulsive move
that shows up on the chart as a Price Value Gap.

The requirements of the highest high for a bearish OB and the lowest low for a bullish OB are one
varia on. Any last opposite candle before the following impulsive move can also be considered an
OB. The trader should try both variants himself to understand which OB gives him be er results.

Why do order blocks work?

Large banks and ins tu ons (big players) that have huge amounts of funds at their disposal cannot
place all their orders at one me. If they did, rapid movement would occur and these ins tu ons
would then be unable to fill their orders at a price that is favorable to them. Therefore, they place
their orders in the market gradually. The market o en sees these areas as consolida on.

Once the orders are ready, they trigger an impulsive move, which they o en use various
fundamental news to do. Within that impulsive move, several scenarios can then occur. One is that
not all orders were filled during the impulsive move and therefore price reverts back to those order
blocks.

pg. 23 XS.com
This return to the order block level is due to the need to balance supply and demand. This is because
during a rapid move, an imbalance will occur, which shows up on the chart as a Price Value Gap (or
imbalance), and the price will return to the order block to bring the market into balance. Only then
will the price con nue the movement created by the order block.

Where can I find order blocks?

Order blocks can be found on any me frame, from minutes to weeks, and can be used in any
market, including stocks, futures, forex, and cryptocurrencies. Trading with order blocks can be
combined with other technical analysis methods such as trend lines, moving averages, oscillators
or candles ck forma ons. They can be used to confirm trades or to iden fy poten al stop loss and
take profit trade setups.

How to recognize an order block on a chart trading pla orm

As we have already men oned, an order block is the last reversal candle before a strong move that
creates an imbalance in the market. Price is likely to return to these zones before triggering another
impulsive move to con nue its trend.

How to recognize a bear order block

According to the variant where the last highest bullish candle formed before the downward
movement is considered to be a bearish OB, such a candle would be candle 1.

Bearish order blok

If we consider the OB to be the last bullish candle before the strong downward move, then it is
candle A. We consider the OB to be the size of the whole candle. The impulsiveness of the move is
confirmed by the Price Value Gap.

pg. 24 XS.com
How to recognize a bullish order block

At point A is the last bearish candle before the next strong bullish move. The price then quickly
moved upwards, which is confirmed by the Price Value gaps. We consider this en re candle to be an
OB.

Bullish order blok

A possible op on is to consider the last bearish candle that was the lowest before the impulsive
move (candle #1) as a bullish OB.

You need to find a valid demand/offer area

1. You need to find a valid demand/offer area

A valid supply/demand area is where prices are rising (or falling) rapidly and breaking the structure
(BOS). Thus, in the case of an uptrend, it creates a break of the previous high (resistance becomes
support), in the case of a downtrend, it creates a break of the previous low (support becomes
resistance).

Alterna vely, the second case is possible, when a change of character (CHOCH) occurs. Thus, in an
uptrend a higher low will be broken and in a downtrend a lower high will be broken.

pg. 25 XS.com
Break in structure (BOS) and change in structure (CHOCH)

2. The breakthrough must be valid

Examples of valid and invalid breakthroughs are shown in the next figure:

Examples of valid and invalid breakthroughs

The figure shows a break with bearish candles. The analogous procedure is in the case of bullish
candles with the difference that it is a resistance break. Prac cally, the idea is that the break of
support or resistance is confirmed by the body of the candle, i.e. not by its mere wick.

pg. 26 XS.com
 3. The movement must be unbalanced (impulsive)

An imbalanced movement is signalled in the chart by the Price Value Gap. This gap signals
impulsiveness. In the next picture, there is a bullish OB (candle A) and the blue rectangles show the
Price Value Gaps. It can be seen that the price is quickly moving away from the OB.

Price Value Gaps occur between three candles and it is a situa on where the wicks of the first and
third candle do not touch or overlap.

Imbalances following OB

We consider these OBs that have generated impulsive movement as valid and try to search for them
in the graph.

The next figure shows a bear OB with an imbalance mo on.

pg. 27 XS.com
Balanced movement, no signs of impulsiveness

Candle A is the last highest bullish candle before the next decline. However, in this case, the candles
overlap, there are no Price Value Gaps, the prices form a balance, so there is no sign of
impulsiveness. Order blocks that form in a balanced move are be er not to be taken.

Prac cal demonstra on of using order block in trading

We will demonstrate the use of OB on the currency pair USDJPY, which is shown in the following
picture:

Bullish OB on the USDJPY pair on the H4 chart

There is a bullish OB at point 1. It is the last bearish candle before the next upward move, which
marks the rising trend line. A Price Value Gap has formed between candle number 1 and number 3.
The OB is therefore valid. Then we wait for the price to return to this OB. A er that, the entry is in
the long direc on.

In the next picture we have an example of a bearish OB in a downtrend situa on:

pg. 28 XS.com
Gold on D1 chart (HH-higher high, LL- lower low, HL- higher low, LH - lower high)

Gold has formed a lower low (LL) and a lower high (LH). There was a break of the lower low (BOS)
and a bearish order block (last bullish candle before the breakout) was formed at this point. This
break was also accompanied by a Price Value Gap. Price later returned to the order block and would
have offered a trade with 3R poten al if we had speculated to the previous LL.

Note on entry

The figure shows that the entry was virtually the moment price touched the OB boundary. However,
since the Price Value Gap was not completely filled, this is a disadvantageous and even risky entry
because the Price Value Gap represents a gap that tends to fill.

To take advantage of the signal using OB, it will be more appropriate to wait for the Price Value Gap
to be filled, which is close to OB. This will happen if the OB is not part of the Price Value Gap (i.e. its
first candle). Once the Price Value Gap is filled, you will move to a lower meframe, on which you
will then look for some confirming candle forma on to indicate a move in the expected direc on.

pg. 29 XS.com
Entry a er filling the Price Value Gap

In this case, the trade would offer pa ent traders a profit of almost 6R if the entry was made a er
the Price Value Gap was filled.

7 ps for easier iden fica on of order blocks

1. Analysis on a higher me frame

Start by analyzing charts on a higher me frame, such as daily, weekly or monthly, to iden fy
significant price levels where a BOS or CHOCH has occurred. These levels are o en where
ins tu onal orders are expected to be placed.

2. Zones of consolida on

Before a strong move, price usually consolidates.

3. Finding order blocks

Once support and resistance levels are iden fied, look for order blocks ahead of strong Price Value
Gaps.

Iden fy the last bearish candle before a strong upward move or the last bullish candle before a
bearish move.

4. OB Confirma on

Verify the validity of the OB and the overall market context. Trading OBs that are countertrend are
a risky op on. It is preferable to trade in the direc on of the iden fied trend.

pg. 30 XS.com
 5. Retest OB

Once an order block has been iden fied, wait for price to return and retest the area. Here traders
expect ins tu ons to be interested in entering the market. Prefer only untested OB. If the OB has
an unfilled Price Value Gap, wait for it to be filled.

6. Confirma on by price ac on

To confirm entry, move to a lower meframe (for example, from D1 to H4, from H4 to H1 and from
H1 to 15min) and look for confirma on using a candle forma on such as pin bars, engulf or doji.
These forma ons can give higher assurance as to the correctness of the direc on of the next move.
However, some mes they can worsen the Risk Reward Ra o.

7. Watch out for fundamentals

Keep in mind that OBs can be disrupted by significant fundamental news or events. So find out what
fundamental events are on the calendar. This is especially true if you are an intraday trader.

Risks of using order blocks

Iden fying actual order blocks takes prac ce and can o en be subjec ve. The risk is that ins tu onal
traders may change their strategies, invalida ng previous order blocks. Unfortunately, as retail
traders, we do not have the same informa on as ins tu onal traders and the true mo ves of any
large market player to move impulsively at any given me will never be clearly revealed to us.

As this strategy requires a certain amount of experience, backtest yourself using a demo account
to see under what condi ons you will use this strategy and on what me frame or instrument it will
suit you best.

The order block trading strategy is an approach that aims to iden fy key support and resistance
levels on price charts, referred to as "order blocks," and use them as poten al entries or exits from
trades. The basic idea is to assume that significant buying or selling by large ins tu ons occurs at
these levels, which influences future price movements.

pg. 31 XS.com