Fair Value Gaps & Liquidity Voids: Examples, Explanation, & How to Trade

What are Fair Value Gaps and Liquidity Voids?

Fair Value Gaps (FVG) and Liquidity Voids are price ranges you can exploit for better entries and exits on your trades. They're similar concepts, so let's look at them from the top and break it down.

Think of FVG and Liquidity voids as soft-spots in the market. They are paths of least resistance. That doesn't mean price will go through them, but price could go through them more easily.

You may have heard traders talk about the gap-fill phenomenon, the idea that "gaps want to be filled". This idea relates to that pattern, so we'll go through how and why.

Defining Fair Value Gaps (FGV)

Fair value gaps are ranges where you might seek an entry for a planned trade. It's a specific candle pattern based on the concept of liquidity voids.

Fair value gap patterns consist of three candles. The "gap" is the price range that is not shared by candles one and three. Candle two is generally a larger candle, providing a wide price range.

How to Spot Fair Value Gaps

The fair value gap in the image above is a buy-side fair value gap. Traders seeking a short entry might use this as their entry point. They'd have confidence in that entry because they expect buyers to push price into that FVG on a later candle.

As you can see, in candle 2, price has moved quickly down, leaving a liquidity void. Candle 3 has closed lower, not coming into the range of candle 1.

How do Fair Value Gaps Form

Fair value gaps form in three bars.

1. Price moves outside the range of the first bar.
2. The second bar passes quickly through the range outside the first bar.
3. The second bar closes near the outside of its range.
4. The third bar enters the range of the second bar but fails to enter the range of the first bar.

Fair value gaps can form on up moves or down moves, over any timeframe. The key ingredients are:

• Bar 2 is generally large, almost always larger than Bar 1.
• Bar 1 and Bar 3 do not share any common prices.

Fair value gaps create a small liquidity void, to which traders may expect price to return in later bars. For that reason, fair value gaps can be a desirable entry point.

How to Trade Fair Value Gaps

As with all patterns, how you trade FVGs is up to you. But, most traders look for FVGs as entry points. Personally, I use them as entry zones.

The fair value gap is a short-term liquidity void, and I expect price to trade into liquidity voids. So, if I have a setup, I will place an order there rather than chasing a move. 

For short entries, candle 2 should be a down candle. It's helpful if candle 3 is an up candle, but that's not required, at least for me. But it does show that buyers are trying to push into that range.

For long entries, candle 2 should be an up candle. The same goes for candle 3 there, but in reverse. 

As you can see in the image above, there were FVG sell entries and FVG buy entries in the span of just 30 minutes.

Short Entry

The "Sell Entry" on the chart is a short entry for the range below. If you were trading a short setup and looking for an FVG entry, you got one that worked. The max profit on that trade was 31 points, as of the time of this screenshot.

Long Entry

If you were working on a long setup and waiting for an FVG entry, you got two that worked. You would have had to take a little pain, but less than if you had chased. The max profit on that trade was 32 points as of the time of this screenshot.

Chase Zone

You can see I labeled the area I call the "Chase Zone" on the chart above. You can also see there was no need to enter in that area, and doing so would have hurt all your trade stats.

You would have to take more pain, which we all hate. But the consequences are far greater. You have a worse entry, so you're starting out behind.

• Your max potential profit is less given any take profit price.
• Your max potential loss is greater given any stop price.
• Your win rate could be lower, depending on your stop price.
• Your Max Adverse Excursion (MAE) will be far greater. In other words, you would have taken more pain.

It's important to note that the fair value gap itself is not a setup. It's a pattern traders look for when they have a setup and need an entry point. You must have some other reason to take the trade.

Liquidity Void Meaning

Liquidity voids are market soft-spots, and they're the simplest piece of this idea. For most of my career I've known them as order vacuums or vertical ranges.

Those vertical ranges typically consist of two or more expansion bars. Expansion bars get their name by expanding the range on the timeframe they occur. Expansion bars move outside the close of the prior bar and close well outside the recent range.

Because they explode outside the range quickly, they leave an order vacuum.

When that order vacuum forms as described above, you get a zone like a gap. Much like a gap, it can act as a "chute" for price.

You can use liquidity voids to determine what ranges you want to trade. They can help you decide potential entry and take-profit points. You can use them to avoid being too loose on a stop-loss. More on that below.

How to Spot a Liquidity Void

Now that you know what to look for, you can start spotting liquidity voids several times a day. Especially in this market (Feb 2023)!

1. Start by watching for vertical ranges.
2. Then look at the expansion bars. It's rare for there to be less than two. Exception: Big market data releases like FOMC
3. If you intend to use liquidity voids in your trades, look for larger ones that give you plenty of range. Sometimes a partial retrace is more likely than a full retrace.

How do Liquidity Voids Form?

Liquidity voids form when price moves through a range quickly in one direction. It moves through that range or price zone without being tested or contested.

When price moves quickly through a range uncontested, a few things happen:

• It clears out the order book. This creates the liquidity void, also called an order vacuum.
• Orders from participants trading in the direction opposite the move are still placing orders, at the edge of that range and into the range.
• Traders trading in the direction of the move haven't adjusted their prices, at least not yet.
• Traders trading in the direction of the move must now decide either to chase or keep their prices where they were. Institutional traders don't chase. So, new participants will have to step in to fill the vacuum, fill the liquidity void. And they'll likely be smaller participants.
• In securities regulated by Regulation NMS, the book may clear so quickly that NMS is suspended. This means that dealers can temporarily ignore the NBBO (National Best Bid/Offer), so traders placing market orders may get "bad fills". This makes these particular areas more prone to retracement.

This happens regardless of how much volume drove the move. It doesn't require high or low volume for a liquidity void to form.

How to Trade Liquidity Voids

You can trade liquidity voids in several ways. This all depends on your own trading style. But I'll cover some ways I use them. Most of these involve using liquidity voids to enhance trading setups.

This is not an exhaustive list. There are other ways to use liquidity voids. How might you use them for your setups?

Limitations of Liquidity Voids

Liquidity voids are a pattern with limitations, just like any other. They form based on real market dynamics, so they're more useful than many patterns. But you still need to know these limitations.

Naturally, a liquidity void may form more easily in areas where the order book is thin. But, and this is important:

• Don't form expectations about where a liquidity void may occur. That's not what this is about. Doing that is asking for trouble.
• Be careful about assuming the market is thin in a range just because of what is on the order book. There are plenty of tricks used to fool those who take the level II data seriously.
• Don't expect price to come back to the edge of a liquidity void just because there is one there. It may never come back to it, or it may take longer than you think.
• Price may go far away from a liquidity void before coming back to it.
• Not all liquidity voids get filled, just as not all gaps get filled.

It doesn't need to be more complicated than that. I see a lot of traders make it too complex. They factor in order flow, block orders, market profiles, and footprints. Before long, there's too much noise and too much room for second-guessing.

Fortunately for you, liquidity voids are simple and straightforward. They exist regardless of those factors. At the same time, liquidity voids are just one piece. You can choose not to use them, or to apply them to your strategy in whatever way works best for you.

Using Fair Value Gaps & Liquidity Voids Together

You can easily combine fair value gaps and liquidity voids to get more out of your trades. In the example below, assume you have some setup to get long. Let's see how using the FVG and liquidity void would help you get a favorable entry and improve your probabilities.

Let's assume in the example above your stop is at 12,077, and your target is 12,121.50

• Had you chased the short:
  • You would have taken as much as 26.5 points of pain (12,103.50 to 12,077).
  • Max potential profit would have been as little as 18 points.
• Had you waited and entered in the FVG:
  •  13.5 of those 26.5 points could instead be part of your potential profit (12,090.50 to 12,103.5 = 13.5 pts).
  • If you made a short scalp, you got a max potential profit of 31.50 points out of it (12121.50 - 12,090 = 31.5).
• From the worst (highest) entry price in the FVG:
  • Your max pain was only 3 points.
  • If price had pulled back to the local low again, MAE would have been 14.5 points (versus 26.5 for the chasers)

What Timeframe Should You Use For Liquidity Voids and Fair Value Gaps?

You can use liquidity voids over any timeframe. Liquidity voids occur across 5-second timeframes and 5-week timeframes. There difference in behavior between price vacuums over different timeframes, though.

Rules of Thumb for Liquidity Void and FVG Timeframes

• Shorter timeframes have shorter time windows for exploitation, and usually smaller ranges.
• Longer timeframes have larger time windows for exploitation, and usually larger ranges.

As with any other trade, you have to apply this concept to your strategy with R/R in mind. If you're trading a wider time range with wider ranges, you'll need to size well for the desired R/R, etc.

Constant Across Timeframes

• Just because you expect price to breeze through a liquidity void doesn't mean it will happen soon.
• Multiple liquidity voids can string together to create a bigger range. There may or may not be consolidation between each void.
• Not all liquidity voids will fill. You should track the fill frequency for liquidity voids over whichever timeframe you choose to trade.
• Only use the liquidity voids over the timeframe you're trading. In other words, don't use a liquidity void on the 4hr chart to trade a setup on the 5min chart.

Liquidity Void Variations Between Timeframes:

Very short timeframe (scalping): Over the 1-10 second timeframe, you have one main difference. That is with how orders come back into the order vacuum.

• Market participants sending orders may not react quickly enough to change their prices.
• This means that you may have orders come into that void immediately but for a very short time.
• These "slow-to-act" participants will inherently be sending orders against the direction of the move.
  • "slow-to-act" orders going with the direction of the move will still be at the 'beginning' prices of the move. This is because they haven't reacted yet to the change in price.

Short timeframes (day trading): Over 15-30min timeframes, liquidity voids can fill quickly or with delay. They may fill in one or two moves, or two sessions later.

• Liquidity voids may be filled fully, partially, or not at all.
• They may even fill multiple times in each direction within the same day.
• They may be partially filled and then filled fully later in the day by a secondary move.
• Or, don't forget, they may not be filled that day.

Longer timeframes (swing trading and investing): On a daily and weekly timeframe, liquidity voids that get filled may take days or months. There may be significant price fluctuations before the void is filled.

What about volume, and order flow?

If you want to use volume and order flow in your trading, go for it. Don't abandon something where you have an established edge.

But I can remind you to verify that edge. Study your journal and the stats to see if adding those to this concept provides edge. In my experience, it does not.

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