Fair value is defined in stocks as the full value of a company, which includes production, buildings, equipment, financial instruments and interests, debt, capital, and everything that can be translated into a firm’s worth.
In futures, it’s the balance between the price of the contract and the interest set to be earned.
But, what is it when it comes to Forex trading?
That’s what we’ll find out in this article. So, grab a drink and read on!
The Concept Of Fair Value Applied To Forex
First off, using fair value analysis with Forex doesn’t mean just analysing the fair value of a currency pair. Fair value in Forex requires studying the country behind each coin, for they’re the translation of a country’s worth.
Therefore, if you wish to apply this approach to Forex, you must study everything that can alter a country’s economic status.
As such, your analyses will be based on the political status of the country, the ideology currently governing, its GDP, economic freedom index, interest rates, and inflation rate, among many others.
Another approach is to study the economic sectors of both countries in a currency pair and score them appropriately depending on their importance and performance.
In the end, fair value applied to Forex means studying the total value of a country, which is translated into their currency’s purchasing power.
Determining Fair Value In Forex
Now, regarding how exactly you can study the fair value of a currency pair, I can point out three main methods.
a. Looking At Countries Like Companies
You can study the economic assets possessed by each country and score them for comparison.
Doing so would find you evaluating their economic sectors, largest companies, GDP, internal and external debt, and similar elements.
For example, if you want to determine the true value of the EURUSD pair, you need to evaluate how the US and the Eurozone are doing in terms of their manufacturing and service sectors—as well as how important they are for each country and then the global economy.
b. Fundamental Analysis
Before explaining anything, most traders would agree that fair value in itself is a form of fundamental analysis since you charts aren’t critical for your studies.
However, when we speak about a fundamental approach to fair value in Forex, we mean looking at the news releases, economic events and reforms, legislation changes, and the overall performance of the government and population.
Once you understand the fundamental status of a nation, you can judge its importance and value by comparing it to other countries.
c. The Price Of A Big Mac - The Big Mac Index
Finally, we have the purchasing power parity of a currency. The PPP can be defined as the real value of a coin when it comes to acquiring actual products in the market.
This can be done by translating the price into USD (or any reference coin of your preference) at the current Forex rate and comparing it with the same results by other currencies.
The Big Mac Index is a popular method to do this thanks to its simplicity; all you need to do is find the price of a Big Mac in two countries, for example, the EU and the UK, convert it to USD and compare it.
The result is the real value of each currency.