The fair value trading is a strategy based on the fundamental analysis which origins from corporate finance, and in particular from the Western accounting standards of IFRS (International Financial Reporting Standards), according to which the fair value of a company is the total value of a company, which takes into account all its assets, liabilities, cost of capital, and other variables.
The fair value analysis is always used in stock markets, in order to evaluate the stock price of a company, but this strategy can also be used in forex trading to evaluate the value of a currency. The aim is to figure out the fair value of domestic economies. It is considered a fundamental-based strategy because it relies on economic data and sometimes on the political situation of a country while comparing them to the same components of another country to evaluate which country will perform better in the short or medium term.
To perform this strategy, a trader must analyse the main macroeconomic indicators of two domestic economies. The most important one is the GDP growth rate of the two countries whose currencies he/she decides to trade. The unemployment rate and the inflation rate are other two important indicators. Not only current values but also expected ones must be taken into account. These data are easily available on the most important financial websites.
After collecting the most important sector data of the two economies a trader must weigh them, depending on the importance of a sector to that country´s total economy. For example, let’s compare the US and the Swiss economies in order to take a decision on the USDCHF pair (e.g. going long or short on the pair). A trader can assign a high score to the US manufacturing, because this sector is very important to most of the large countries in the U.S., while assigning a low score to the Swiss manufacturing, because this only accounts a low percentage on the Swiss GDP. On the other hand, he/she should assign a higher score to the Swiss service sector because it is crucial for the Swiss economy. Once this analysis have been made, the two countries’ economies are evaluated according to the resulting rank, which will be also used later to take forex decisions on the USDCHF.