Fair Value Gap (FVG) Explained: The Three-Candle Rule, Fills and Inversions

A Fair Value Gap (FVG) is a price range the market crossed so fast that it traded in only one direction. On a chart it shows up as a gap between the wicks of the first and third candles of a three-candle sequence, with a large middle candle running through it. Smart Money Concepts traders call it an imbalance: for a moment, one side of the market overwhelmed the other.

FVGs are popular because they are objective. Unlike most chart patterns, you can test for one with a single comparison, and two people looking at the same chart will always agree. This guide covers the exact rule, a worked example, what happens to gaps afterwards, and how to filter out the noise.

The exact condition

Number three consecutive finished candles j, j+1 and j+2:

Bullish FVG:  low(j+2)  > high(j)     gap = [high(j),   low(j+2)]
Bearish FVG:  high(j+2) < low(j)      gap = [high(j+2), low(j)]

gap size        = top − bottom
midpoint (CE)   = (top + bottom) / 2

Candle j+1 isn't in the formula, but it's almost always a large body, because something had to carry price across the gap. If the wicks of candles j and j+2 overlap by even one tick, there is no FVG.

A worked example on NIFTY

Illustrative 5-minute NIFTY candles, with a 14-bar average body of 14 points:

• Test: low(j+2) = 25,131 > high(j) = 25,112. That's a bullish FVG.
• Gap: 25,112 to 25,131, so 19 points.
• Midpoint (consequent encroachment): 25,121.5.
• Size check: 19 points is about 1.4× the average body of 14, so this is a meaningful gap rather than noise.

If price later drifts back to 25,131, the gap is being entered. A close below 25,121.5 means more than half of it has been filled. A close below 25,112 fills it completely.

Why gaps get revisited

Inside the gap, only one side traded. The usual explanation is that orders were left unfilled there, so price tends to come back into the range before moving on. A more mechanical view: fast moves overshoot, and liquidity on the opposite side gets thin, so pullbacks into the gap are common.

You don't need either explanation to use the measurement. An FVG is a precise record of how fast price moved, and of the exact range where it moved fastest.

What happens to a gap afterwards

Many traders pay most attention to consequent encroachment, the midpoint. A strong reaction at the midpoint, without a close through it, is often read as the gap holding. Whichever level you use, decide it before you look at the chart.

Filtering out noise

On a 5-minute chart, a gap of a few paise is technically an FVG and practically meaningless. Useful filters:

• Size relative to normal movement. Compare the gap with the average candle body over the last 14 bars. A gap smaller than a fraction of that is noise.
• Context. Did the middle candle also close through a confirmed swing level? A gap that is part of a Break of Structure is part of a structural move.
• Liquidity before it. A gap that forms right after a liquidity sweep often marks the start of the real move.
• Session time. Gaps in the first minutes after 09:15 are common and fragile. Gaps during the quieter midday session are rarer and stand out more.

Related ideas, and how they differ

FVGs across timeframes

A daily FVG represents an imbalance that lasted a whole session; a 5-minute FVG may last a few minutes. Combining them works well: a 5-minute bullish FVG that forms inside an open 1-hour bullish FVG is aligned with the larger imbalance. A 5-minute bullish FVG right under an open daily bearish gap is pushing into the other side's territory.

How Zone Terminal uses FVGs

In Zone Terminal an FVG is never a setup by itself. It is one of two accepted proofs that a move away from an order block was impulsive. The other proof is a close beyond the origin candle by at least 1.0× the average body of the previous 14 bars. Zones whose proof is an FVG get a "★ FVG Proof" badge, because a gap is the clearer evidence of aggression.

Common mistakes

1. Using the live candle. The third candle's low isn't final until it closes. A gap drawn mid-bar can vanish.
2. Counting overnight gaps. Different cause, different behaviour.
3. Treating every gap as a level. Without a size filter, a 5-minute chart is full of trivial gaps.
4. Assuming gaps must fill. Strong trends leave gaps open. A gap is a measurement, not a magnet.
5. Mixing cash and futures charts. The same move can leave a gap on one series and not the other. Pick one series and stay with it.