Algorithmic pricing engines deliver price through two primary mechanics: seeking liquidity (sweeps) and rebalancing price efficiency. When the market moves aggressively in one direction, it creates an inefficiency or imbalance. The most common and useful way to measure this imbalance is the Fair Value Gap (FVG).

The Anatomy of a Fair Value Gap

A Fair Value Gap is a three-candle pattern that prints during rapid price movement. It is identified by the gap between the wick of the first candle and the wick of the third candle:

  • Bullish FVG: Created during an aggressive upward move. The space between the high (wick tip) of Candle 1 and the low (wick tip) of Candle 3 is the gap. This area represents an price range where only buy orders were delivered.
  • Bearish FVG: Created during an aggressive downward move. The space between the low of Candle 1 and the high of Candle 3 is the gap, representing an area where only sell orders were delivered.

The algorithm views these gaps as inefficiencies and will eventually drive price back into the gap to fill or “rebalance” the missing liquidity before continuing in the original trend direction.

Inversion Fair Value Gaps (IFVG)

An Inversion Fair Value Gap (IFVG) occurs when a FVG is completely breached and closed past by price, rather than acting as support or resistance. Once breached, the gap changes polarity, similar to how support becomes resistance:

  • A bullish FVG that gets broken and closed below turns into a bearish IFVG, acting as resistance when price retraces back up to it.
  • A bearish FVG that gets broken and closed above turns into a bullish IFVG, acting as support when price retraces down.

Practical Trading Application

To use FVGs and IFVGs in your trading:

  1. Wait for a displacement move that shifts market structure and leaves a clear FVG.
  2. Look for price to retrace to the 50% equilibrium level of the FVG (called the Consequent Encroachment). This is your high-probability entry zone.
  3. Use Inversion FVGs to confirm structural failure. If a bullish FVG fails to hold price, look to sell the retest of that inversion gap.