Month: October 2024

Introduction

While the concept of Fair Value Gap (or FVG) is usually associated with long-term investors, it also plays a vital role in short-term trading too. So much so that there are many traders specialized in trading FVGs and little else.

In today’s article, we’ll learn what a Fair Value Gap is, how to identify one, and how to trade it.

Let’s dive in!

What is a Fair Value Gap?

Just as the name suggests, Fair Value Gap trading involves identifying price gaps that occur when the market reacts to temporary changes in a stock’s fundamentals, such as news releases or large buy/sell orders.
These gaps often represent areas where price has moved too quickly, and it may need to retrace to “fill” these gaps, returning to what was previously perceived as the “right” fair value.

In simple terms, an FVG exists when there is a divergence between the current price and the price and the perceived intrinsic value. This gap creates an opportunity for traders to enter or exit positions based on the expectation that the price will move back toward its fair value. And that’s pretty much what FVG trading is all about.

On January 19, 2021, Netflix reported its fourth-quarter earnings. The results showed a massive increase in subscriber growth causing price to gap up massively by the next day’s open.

On January 20, 2021, Netflix’s stock opened at around $565 after closing at around $500 the previous day. The extreme gap presented an opportunity for traders watching for a potential retracement or those looking to short the stock at the top of the gap.

During the following few days, a combination of underwhelming actual profit and investors’ concerns over future growth rates have pushed price back down till the FVG was fully filled.

How do traders identify Fair Value Gaps?

To spot FVGs, traders need to make use of their technical analysis skills and a pinch of understanding of trading psychology.

If you think you have both, here are a few tips you might find useful:

Look for Gaps in Price Action

The simplest method of identifying an FVG is by looking for one on a trading chart. Significant price movements (especially those following news or earnings reports), can create gaps. On a chart, they often appear as a noticeable jump in price between a candle’s close and the next candle’s open price without any trading occurring in between.

Analyze Market Sentiment

As we said earlier, a fair value gap is created when price diverges from the perceived intrinsic value. Since both “current price” and “perceived intrinsic value” are directly linked to market sentiment, this is usually well worth analyzing too.

Tools such as Sentiment Analysis Indicators or the Social Sentiment Index can help you identify prevailing moods in the market.

Check Volume

While high trading volumes during price gaps can indicate strong interest and somewhat confirm the likelihood of the gap being filled, low volume, on the other hand, may suggest that the price movement may not be strong enough to fill the gap completely (or even partially).

Check for Previous Support and Resistance Levels

Historical support and resistance levels can provide insight into ideal levels where price might return to fill the gap.

How to Trade Fair Value Gaps

Now that you know how to identify a Fair Value Gap, the next step is learning how to trade it.

This is what most traders usually do after spotting an FVG and what you can do too to start right now:

Set entry and exit levels

Once you identify a gap, determine the entry point at or near the gap’s optimal price level (the market’s perception of the stock’s intrinsic value). Set your stop-loss orders below the gap for bullish trades and above it for bearish trades.

Follow the market trend

Align your trades with the broader market trend. If the overall market is bullish, go for long positions when entering through FVGs, and vice versa for bearish trends. Following the overall market trend increases the chances of successful trades.

Consider the Fair Value Gap across different time frames

Analyze FVGs across various time frames keeping in mind that gaps in shorter time frames are usually more numerous and can provide more and different opportunities.  Higher time frames, on the other hand, often have more significant implications and dramatic retracements.

Monitor Market News:
Be aware and keep an eye on upcoming news events or economic data that might impact the asset’s price. These events can sometimes cause sudden volatility and potentially affect your FVG trading strategy.

Backtest Strategies:
As for all other trading strategies, do use your diligence, and use historical data to backtest your FVG trading strategy before implementing it. Check results to evaluate performance and make the necessary adjustments.

Following news of an antitrust investigation launched by the Chinese Government on Alibaba (BABA), the stock price dropped from around $255 at the 23rd December 2020 market close to just above $211 at the opening of the following day thus creating an FVG of over 17%.

Once again, positive sentiment toward the stock and strong sales figures pushed price back up to fair value and made FVG traders exceedingly good profit in just a few days.

Conclusion

Fair Value Gap trading offers a unique perspective on price movements and market inefficiencies, and it allows FVG traders to step into positions that match their expected price corrections.

Once you fully understand how to identify, analyze, and trade FVGs, you’ll have added another great tool to your trading arsenal. It’s only forward and upward from there!

Hope this helps!

 

Introduction

As promised in our previous article “The 5 Most Popular Order Types Explained”, this next one is all about the Trailing Stop Order.
We decided to leave this order type to last and dedicate to it a separate article so that we could properly explain what a trailing stop order is, how it works, and what we need to be mindful of when using one.

Without further ado, let’s dive in.

What is a Trailing Stop Order?

A trailing stop order (or trailing stop loss order) is a dynamic trading tool that helps protect profits and manage risk by automatically adjusting the stop-loss level as the market price moves in your favor.

Rather than being set at a fixed price like a traditional stop loss order,  a trailing stop moves in tandem with the market price, allowing traders greater flexibility in terms of both risk and trade management.

Here is an example of how a trailing stop loss order is often used:
Let’s say you studied Nvidia’s (NVDA)  hourly chart and decided to open a short position by market order. Let’s say price moves immediately in your favor taking your trade into the green. If NVDA’s price keeps dropping to a level you are happy with, you could first move your stop loss to break-even level – to avoid the risk of a currently profitable trade into a losing one – and then turn your stop loss into a trailing stop loss. This would allow you to “set aside” a portion of your profit that increases as price keeps moving in your favor and, at the same time, protect it against any sudden reversal.

How do you set a trailing stop order?

As we said, a trailing stop order can help you to manage your trades and your risk and, whether you choose to use it as part of your strategy or not, we think it is nonetheless important to at least learn and understand how to use it.

To set a trailing stop loss order you will first have to decide the trailing stop loss range, step, and start.

The trailing stop loss range

The trailing stop loss range is the distance between the trailing stop and the trade’s high (for long positions) or low (for short positions).

For example, if a trader buys a stock at $50 and sets a trailing stop loss range equal to $20, he/she will see the trailing stop moving to the $60 level when price reaches $80, to the $80 level when price reaches $100, and so on. If price drops from $100 to $90, the trailing stop will remain on the $80 mark. If price drops to $80, an automatic market order will be created and the position will be closed (sold at best available price).

You can set a trailing stop order in three different ways:

1. by percentage,
2. by dollar amount (or any other currency the asset is denominated in),
3. by technical indicator.

Percentage-based trailing stop range

This method allows traders to specify a percentage by which the price must drop from its highest point (for long positions) or rise from its lowest point (for short positions) before the order is executed.

For example, if you set a trailing stop order at 5% on a stock that has risen to $100, the stop order is executed if price drops to $95.

Dollar amount trailing stop range

To set your trailing stop loss range in dollar terms, you would define a fixed dollar amount for the trailing stop as we described earlier.
For example, if a stock rises to $50 and you set a trailing stop at $2, your stop order will activate if the price falls back to $48.

Indicator-based trailing stop range:

Although this is easier done with EA, some traders prefer to use a technical indicator (or values derived by an indicator) to define their trailing stop.
The ATR, for example, is a very popular way of setting trailing stops, with 1x ATR and 1.5x ATR’s value being among traders’ favorite ranges.

In this example, you can see an open trade running on Coca-Cola’s Stock (KO). You can see the opening price, the original stop loss, the trailing stop start, the range, and the current position of the trailing stop itself.

The trailing stop step

When setting your trailing stop loss order step, you’re dictating how much price must move to provoke each stop loss adjustment.

For example, say the stock you are trading has reached a price of $50 and you have set a trailing stop loss order with a range of $10 (currently resting at $40) and a step of $3, the stop loss will not move to $41 when price moves to $51. Instead, it will move directly to $43 only if and when price reaches $53.

The trailing stop start

The trailing stop order start indicates the conditions that must be present for a simple stop loss to turn into a trailing stop loss.

For example, you might decide to set the trailing stop at the $100 profit level which means that only when your position reaches $100 profit, your trailing stop will start following the price.

 

A few points to keep in mind when using trailing stop orders

While trailing stop orders’ benefits are easy to see, you must remember they are not perfect and they too come with their drawbacks.

Always beware of:

Market Gaps

When market conditions are extremely volatile (for example just before and after market news), prices may move dramatically, which can lead to slippage. This means your order could be executed at a different price than expected, especially if the asset gaps down significantly.

Introduction

We find ourselves talking about technology a lot when it comes to online trading, and there are very good reasons for that. After all, other than making online trading possible in the first place, the advancement of technology has also provided traders with the practical tools to fine-tune their strategy to virtual perfection. The different order types that brokers and prop firms offer to their traders are excellent examples of these tools.

Each order type allows traders to set the conditions that dictate how, when, and/or at what price an asset should be bought or sold according to their trading strategy. This allows for positions to be opened and closed automatically, thus reducing the need for constant screen monitoring.

In today’s article, we’ll take a look at the five most common order types available to retail traders while also learning how and when to each of them.

Ready?
Let’s get on with it!

The 5 most popular order types available to traders

The five order types we are about to explore are Market Orders, Limit Orders, Stop Loss and Take Profit Orders, Stop Limit Orders, and Trailing Stop Orders.

Remember, each order type serves a unique purpose and its use can significantly affect your trading strategy, risk management, and overall success in trading the market.

1. Market Orders

   Easy, quick, and direct

   A Market Order is the simplest and most straightforward order type. When you place a market order, you are instructing your broker to buy or sell a security immediately at the best available price. This order type is advantageous when you want to enter or exit a position quickly, especially in a rapidly moving market.

   
   Say you are trading Microsoft stock (MSFT) and your strategy tells you it’s time to open a long or a short position right now because you think price could start moving in your favor imminently. In a case like this, a Market Order’s instant execution may just be what you need.

   However, there are some caveats with Market Orders.
   Because market orders are executed at the best current market price, you may not have control over the exact price at which your trade is executed.
   In volatile markets, this can lead to slippage, where the final execution price differs from the one you were expecting to pay. Despite this, market orders are often the go-to choice for traders prioritizing speed over precision.

2. Limit Orders

   Control over price

   When the trading strategy suggests a retracement and opening a trade at a different price than the current one,  the use of Limit Orders allows traders to specify the exact price at which they want to buy or sell an asset.
   By setting a buy Limit Order, you are instructing your broker to execute the trade only at the price you choose or lower (but not higher). Vice versa, by using a Sell Limit Order, you are ensuring your asset won’t be sold for a price lower than the one of your choosing.

   Traders usually use limit orders when they believe price might pull back to a certain level before moving in their desired direction.

   
   Let’s go back to the same Microsoft (MSFT) hourly chart but, in this example, let’s say you are bullish but your strategy suggests a small retracement before rising in your favor. Let’s say you decided to draw Fibonacci Retracements on your chart and identify a likely bull back to the $426.17 level. Well, now you can either wait glued to your screen until price retraces to the level you expect or you can set a limit order at that price and go make yourself a coffee. Your broker will execute your trade at the price you’ve set or lower.

   The downside, of course,  is that limit orders are not guaranteed to be executed. If the market price does not reach your limit order price, your trade will not go through, which means you might miss out on some opportunities.

3. Stop Loss Order

   The Safety Net

   Stop loss orders (or stop orders)  are particularly useful for managing the risk associated with each trade and, while other order types might seem a little more complex to some, virtually all traders understand how a stop loss order works. Those who don’t, usually pay the price for it.

   In simple terms, a stop order is an instruction to your broker to close a position (or part of it) if and when price moves against you and reaches a certain level (called the “stop price”).
   To execute your order, once the stop price is breached, your broker will immediately convert your stop order into a market order which will be executed at the best available price.

   

   For this next example, we’ll look at Tesla’s (TSLA) hourly chart. Let’s say you are bullish on Tesla and predict that price will keep rising. However, you acknowledge the possibility of a pullback to the resistance level and believe that if price drops further than that resistance, it might reverse trend and carry on dropping.
   In a casa like this is advisable to set a stop loss just underneath the resistance level to reduce any risk.

4. Take Profit Order

   The profit realizer

   Just like the stop loss order, a take profit order is an instruction to your broker to close a position (or part of it) when price reaches a certain level. However, while a stop loss is triggered when price moves against you, a take profit order is triggered when price moves in your favor and, while a stop loss is used to limit risk on a losing trade, the take profit order is used to realize the profit before a potential reversal.

   

   Let’s go back to the scenario described in Image 3. You are bullish on Tesla, you opened a long position and also set a stop order below the nearest resistance level. Now, setting a take profit order too would allow you to automatically “cash in” the profit your trade would make you if price reaches the level you’ve set.

5. Stop-Limit Order

   The hybrid approach

   Stop-limit orders combine the features of stop orders and limit orders.
   To set a stop-limit order, a trader needs to set a stop price to activate the order and a limit price to specify the maximum price at which they are willing to buy or sell. In other words, the stop price works as a trigger that switches on the limit price order.

   

   To better explain how a stop-limit order works and when it is most useful, let’s take a look at this example. Let’s say you have studied Apple’s (AAPL) hourly chart and come to the conclusion that if price drops further than its latest low, it is bound to keep dropping and begin a bearish trend. If you intend to wait to see if price actually does drop all the way to the latest low for confirmation before opening a short trade – as we learned today – you cannot use a Market Order (since it would execute immediately at the current price) nor a Limit Order (as – in a short trade – they execute at a price equal or higher than the limit price you set and would, therefore, also execute immediately).

   A Stop-Limit Order, on the other hand, would allow you to instruct your broker to create a limit order at your limit price only if and when price reaches the stop price.

6. Trailing Stop Order

   Yes, we said five but there is actually a sixth

   A trailing stop order is an advanced order type that allows traders to lock in profits while giving their profits some room to grow.
   It automatically adjusts the stop price at a specified percentage or dollar amount below the market price for buy orders (or above for sell orders).

Bcause it more advanced and more complex, we decided to dedicate to trailing stop orders an entire article per se. So, if you want to keep mastering the art of trade and risk management through the use of different order types, don’t miss our next article on Trailing Stop Orders!

Hope this helps.