A fair value gap is a three-candle price imbalance that forms when a large market order moves price so quickly that one side of the order book gets skipped entirely, leaving a pocket of unfilled price that traders watch for a future retest.
How a fair value gap forms
In a bullish fair value gap, a strong displacement candle pushes price up so fast that the low of the third candle in the sequence sits above the high of the first candle, leaving a visible gap between them on the chart. That gap represents price the market moved through without much two-sided trading, and because market makers generally prefer to see both sides of a level get tested before a trend continues, price frequently returns to fill part of that gap before resuming its original direction.
Why liquidity sweeps happen before the real move
Retail traders tend to cluster stop-loss orders just above obvious swing highs or just below swing lows, since those are the levels visible to everyone on the chart. A large institutional buyer cannot fill a big order without moving price against itself, so it is common to see price briefly poke above a swing high, triggering those stop-loss and breakout buy orders, before reversing sharply once that resting liquidity has been absorbed. Recognizing this pattern helps explain why a breakout that looks convincing on a lower timeframe often fails within minutes.
Combining both concepts into one setup
The two ideas work well together: a liquidity sweep clears out the stop orders resting above a swing high, and the fair value gap left behind by the displacement candle gives a specific price zone to enter once the market retraces. A common approach is to mark the midpoint of the gap, sometimes called consequent encroachment, place a limit order there, set a stop just beyond the origin of the displacement candle, and target the next visible swing high or low on a higher timeframe. Because lower timeframe fair value gaps can conflict with the broader trend, most traders only take these setups when the 15-minute signal lines up with the prevailing 4-hour or daily market structure.