Making money is the sole aim of every forex trading adventure. Having traded for many years, a trader’s most frustrating challenge is finding and sticking to a profitable trading strategy. In this article, we are going to look at how to make money from forex using the fair value gap strategy.
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Table of Contents
How to Make Money from Forex Using the Fair Value Gap Strategy
In forex trading, there are numerous types of trading strategies, and this includes the following.
Indicator trading strategy:
The Indicator trading strategy relies on understanding a particular technical indicator and its operation under different market conditions. This is to say that, as numerous indicators are built as default programs in different trading/broker platforms, such functions differently and uniquely from each other. For instance, a trend indicator such as a moving average functions differently and uniquely from an oscillator like the relative strength index (RSI). Although both indicators are used for technical analysis, they are entirely different in terms of mode of operation.
Price action strategy:
Price action trading strategy relies upon a good understanding of price movement. In trading price movement, many strategies have been developed over the years, some of which include the following:
- Price structure Trading (Naked charts)
- Demand and Supply Trading Concept
- Smart Money Concept (SMC)
- Order Block Trading
- Candlestick and candlestick patterns
- Charts and patterns
- Quasimodo Trading Technique
- Support and Resistance
- Fair Value Gaps (Price imbalance and Inefficiency)
- Trendline Trading, etcetera.
Understanding the principles and concept of trading the fair value gap strategy is one of the hidden secrets behind profitable trading, especially for pure price action traders. This is because price inefficiency is one of the driving force behind pullbacks in any trending market.
What is a fair value gap?
A fair value gap is simply a fair price of a financial asset compared to the current price. It is called fair because it is believed to be a point where the market left a price void known as inefficiency or an imbalance. This price void is regarded as a place where the forces of demand and supply are expected to balance themselves, thus filling up untaken market orders before resuming a trend. So, when the price returns to this fair zone, traders are expected to maximize the opportunity by buying or selling such an asset, depending on the trend direction.
A fair value gap is one of the most critical technical analysis strategies for entry and exit positions. It serves as a point of balance in a trend. When it occurs, it leaves a void on the price chart in different time frames. Although such voids may not always get filled, they serve as zones where traders expect the price to return before resuming the original trend. When this happens, long or short positions are filled and traded.
Why is a fair value gap critical?
A fair value gap is an important technical analysis strategy because it is the point where price inefficiencies are filled. Like in the accounting field, when an account is not well balanced, some loopholes must be checked to know if transactions carried out within the day or a specified time led to profit or loss. In the same way, when forex prices do not balance themselves at the end of a trading session, it leaves an imbalance that must be filled before determining the percentage movement per trading period.
How to determine a fair value gap
The following steps must be taken to determine a fair value.
1. Identify a previous trend:
A trend occurs when the price moves upward or downward. When this happens, it is possible for a fair value gap to be created, as shown in Figures 1 and 2 below. In Figure 1, the market trend is upward and is marked by significant swing highs and lows (Figure 2).
FIGURE 1: SHOWING THE PREVIOUS TREND OF CRASH 300 IN AN EIGHT-HOUR TIME FRAME
FIGURE 2: SHOWING CRASH 300 TREND MARKED BY SIGNIFICANT SWING HIGHS AND LOWS
2. After the previous trend has been identified, candlesticks with high volumes or wick should be observed for fair value gaps. When this is done, such should be labelled appropriately
FIGURE 3: SHOWING A MARKED AREA (GREEN) WITH FAIR VALUE GAPS CANDLESTICKS
FIGURE 4: CANDLESTICKS WITH STRONG MOMENTUM AND WICKS WITH FAIR VALUE GAPS
3. After identifying a fair value gap, mark out the zone and label it appropriately.
FIGURE 5: SHOWING A LABELLED FAIR VALUE GAP POINTS IN CRASH 300
4. Be patient enough to allow the price to return to the zone. When this happens, you cannot take random or losing trades.
How to trade a fair value gap
In trading a fair value gap, the following steps must be noted.
- Take an open position when the price returns to the gap zone.
- Open positions should be taken with considerable lot size. This is because there are situations where the market can react either higher or lower to other subsequent fair value gaps. For that reason, it is always good to carryout analysis on higher time frames so as to have a broader view of the price direction.
- Use the zone above or below it as a stop loss and take profit area.
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