A fair value gap is a hole in price that three candles in a row leave behind. The first and third candles do not overlap, because the middle candle moved so far that nothing traded in between.
What a gap is, exactly
Take three candles that closed one after another on the timeframe you name.
- A bullish gap is there when the third candle's low is above the first candle's high. The gap is the space between those two prices.
- A bearish gap is there when the third candle's high is below the first candle's low.
The middle candle is not measured. You can set a minimum gap size in ticks; a gap smaller than that is ignored. Left empty, any gap counts. A gap that is a whole number of ticks is measured as exactly that many ticks.
The fair value gap block
This block fires when a gap forms. The signal comes at the close of the third candle, which is the first moment the gap exists, in the gap's direction: a long from a bullish gap, a short from a bearish one.
The inverse fair value gap block
This block remembers every gap for a number of candles you choose, and fires when a later candle closes beyond the far side of one: below a bullish gap's bottom, or above a bearish gap's top. The gap is then treated the other way round, so a bullish gap that price closed through is a short, and a bearish gap closed through is a long.
A wick through the gap does not count; only a close does. Each gap can fire once. After the number of candles you set, a gap that was never closed through is forgotten. If one candle closes through gaps in both directions at once, there is no signal, because the candle states no single direction.
Where the stop goes
Both blocks offer four places for the protective stop:
- The far side of the gap. On the fair value gap block, the side of the gap away from the trade: its bottom for a long, its top for a short. On the inverse block, the far side of the gap that price closed through.
- The middle of the gap. Halfway between its top and bottom.
- The pattern's extreme. On the fair value gap block, the lowest low (for a long) or highest high (for a short) of the three candles. On the inverse block, the low or high of the candle that closed through the gap.
- A swing. The lowest low or highest high of a number of candles you state.
You can add a buffer of ticks beyond any of them.
What can go wrong
Both read closed candles on the timeframe you name. A gap on one timeframe is often not a gap on another, so if a signal seems to appear from nowhere, check the timeframe on the block.
The two blocks also take a gap across a market closure, such as a weekend, exactly as they take any other: three candles in a row are three candles in a row.