Markets constantly seek equilibrium. When price moves too fast in one direction, it creates inefficiencies that tend to be corrected over time. Understanding price inefficiencies and mean reversion can help you identify high-probability targets and entry zones where price is likely to return.
What Are Price Inefficiencies?
Price inefficiencies occur when buying or selling pressure is so strong that normal two-way price discovery does not happen. This creates gaps, imbalances, and extended moves that leave price stretched from fair value. Markets have a tendency to revisit these areas to restore balance.
Key principle: Price tends to revisit areas where inefficient price delivery occurred. These inefficiencies act as magnets, drawing price back to fill the gaps and rebalance supply and demand.
Types of Price Inefficiencies
1. Fair Value Gaps (FVGs)
Gaps between candle wicks where one side completely dominated:
- Created by three-candle formations
- Middle candle is impulsive
- Gap between candle 1 wick and candle 3 wick
- Price often returns to fill these gaps
2. Opening Gaps
Price gaps between one session close and next session open:
- Overnight news or events cause gaps
- Statistics show most gaps eventually fill
- Gap fills can be same-day or over multiple days
3. Volume Voids
Areas where little trading volume occurred:
- Price moved through quickly
- Few transactions at those prices
- Low volume nodes on volume profile
- Price can move quickly through these areas again
4. Extended Moves
Price far from moving averages or VWAP:
- Rubber band effect
- Mean reversion tendency
- Extreme RSI readings
Price Inefficiency Example
TSLA gaps up $20 at open after positive earnings.
The gap creates a fair value gap between $240-260.
Price rallies further to $280 but begins to fade.
Over the next three days, price retraces and fills the gap down to $250.
The inefficiency is corrected as price revisits the gap zone.
Mean Reversion Concepts
Mean reversion is the tendency for price to return to average levels:
Moving Average Reversion
- Price stretched far from 20 MA tends to revert
- 50 and 200 MA act as longer-term mean
- Measure extension in ATR multiples
VWAP Reversion
- VWAP represents average price weighted by volume
- Price extended from VWAP tends to revert
- Standard deviation bands show extension levels
Bollinger Band Reversion
- Price at upper/lower bands is extended
- Tends to revert to middle band (20 MA)
- Band touches signal potential reversal
Trading insight: Mean reversion works best in ranging markets. In strong trends, price can stay extended for long periods. Always consider the trend context when trading mean reversion.
Trading Price Inefficiencies
Strategy 1: Gap Fill Trades
- Identify opening gaps or fair value gaps
- Wait for price to start filling the gap
- Trade in the direction of the fill
- Target the opposite end of the gap
- Stop beyond the gap high/low
Strategy 2: FVG Entry
- Identify a bullish FVG in an uptrend
- Wait for price to retrace to the FVG
- Buy within the FVG with stop below
- Target the previous high or next supply zone
Strategy 3: Mean Reversion Fade
- Identify extended price (far from MA, at Bollinger bands)
- Wait for reversal confirmation
- Trade back toward the mean
- Target the moving average or VWAP
Mean Reversion Trade Example
QQQ sells off sharply, dropping 5% in two days.
Price is now 3 ATR below the 20-day moving average.
RSI reaches oversold levels at 25.
A hammer candle forms showing buying interest.
Traders buy with target at the 20 MA (mean reversion).
Price rallies back toward the moving average over the next week.
Identifying High-Probability Inefficiencies
Not all inefficiencies are equal. Focus on these factors:
Size of the Inefficiency
- Larger gaps and imbalances are more significant
- Compare gap size to average daily range
- Bigger inefficiencies have stronger magnetic pull
Location in Structure
- Inefficiencies at key support/resistance matter more
- Higher timeframe inefficiencies are more significant
- Inefficiencies that break structure have more weight
Age of the Inefficiency
- Recent inefficiencies have higher fill probability
- Older unfilled inefficiencies may be less relevant
- Market conditions may have changed
Inefficiencies as Targets
Use price inefficiencies to set profit targets:
Target Setting
- Identify unfilled gaps above/below current price
- Use FVGs as potential take-profit zones
- Target the 50% fill level (equilibrium point)
- Or target the full fill for maximum profit
Multiple Targets
- Take partial profits at 50% fill
- Hold remainder for full fill
- Trail stop to protect profits
When Inefficiencies Do Not Fill
Not every gap or imbalance fills. Watch for:
- Strong trends: Trending markets may leave inefficiencies unfilled
- Breakaway gaps: Gaps that start new trends often do not fill
- Time decay: Very old inefficiencies lose relevance
- Fundamental change: Major news may invalidate technical levels
Use stops to protect against non-filling scenarios.
Tools for Identifying Inefficiencies
Volume Profile
Shows where volume occurred at each price level. Low volume nodes indicate inefficiencies.
VWAP and Standard Deviations
VWAP shows fair value. Standard deviation bands show extension levels.
ATR Extension
Measure how many ATRs price is from moving averages to quantify extension.
RSI Extremes
RSI above 70 or below 30 indicates potential mean reversion setups.
Track Your Mean Reversion Trades
Pro Trader Dashboard helps you analyze your inefficiency-based trades and measure your fill rate success.
Summary
Price inefficiencies occur when one-sided pressure creates gaps, imbalances, and extended moves. Markets tend to revisit these areas to restore efficient price delivery. Types of inefficiencies include fair value gaps, opening gaps, volume voids, and extended moves from moving averages. Trade inefficiencies by fading into gaps for entries or targeting them for profit-taking. Mean reversion strategies work well when price is far from VWAP or moving averages. Focus on larger, more recent inefficiencies at key structural levels for highest probability. Always use stops since not every inefficiency fills, especially in strong trending markets.
Learn more: fair value gaps and VWAP trading.