Fair value gaps: what displacement leaves behind

The three-candle definition

A fair value gap is the space left behind when three candles print and the first and third don't overlap. Take candle one's high and candle three's low, in an up move — if candle three's low sits above candle one's high, that gap between them never traded. No orders filled in that range. It's just space the market skipped on the way through.

I don't need indicators to see this. I need the three candles and a ruler. If the gap is there, it's there — it either exists mechanically or it doesn't, no interpretation required. The same logic runs in reverse for a down move: candle three's high has to sit below candle one's low. Direction changes, the check doesn't.

Why displacement creates it

Gaps like this only show up when the middle candle moves fast enough that price doesn't have time to trade every level on the way through. That's displacement — an aggressive, wide-range candle expanding away from a level instead of grinding through it. Slow, overlapping candles don't leave gaps behind, because every price level along the way gets touched. A gap is proof that whatever pushed price through that range did it with force, not with a series of small trades working the level.

That's the part I actually care about. The gap itself is just geometry. What it tells me is that real conviction moved through that range, and conviction like that usually isn't finished after one candle. A wide gap after a slow, choppy stretch of price tells me something changed — the pace of the market shifted, not just the direction.

First return, and which ones matter

Price often comes back to fill part or all of a fair value gap before continuing. I treat the first return into a gap differently than any later touch — the first time price comes back, it's testing whether the displacement that created the gap still means something. If it holds and continues, the gap did its job. If price grinds all the way through it and keeps going the other direction, the gap wasn't defended and I don't force a second read on it.

Not every gap is worth watching. A fair value gap that formed in the direction of the current bias, off a break of structure, is doing real work — it's the footprint of the move I actually want to be part of. A gap that formed against bias, or off some random mid-range candle with no structural break attached to it, is noise. I only mark the ones tied to a displacement that also broke structure or confirmed a bias I already had reason to hold. Marking every gap on the chart just gives me more places to second-guess an entry.

Consequent encroachment, kept simple

I split the gap at its midpoint and call that line consequent encroachment — the point where price has filled half the empty space. It's the level I actually watch on a return, not the top or bottom of the gap. Price reaching the midpoint and holding tells me the gap is still doing its job. Price trading fully through the midpoint and out the other side tells me it's failing, before it ever closes past the whole range.

On NQ this is where I get patient. A displacement candle prints through the New York open, leaves a gap behind, and I'm not entering on the first tick back into it — I want to see how price behaves at that midpoint. That's the difference between reacting to a level and waiting for the level to prove itself. The gap tells me where conviction was. The midpoint tells me if it's still there.