Currency Pair Fair Value
Just quickly following up with a question from Ralph, who’s asking us what exactly is a fair value area? And how can we define it and use in our trading?
So first of all, thanks for the question, Ralph. Now, when it comes to fair value areas, we can quickly use the example of house prices as a quick analogy.
When you drive around in your neighbourhood, you can quickly get a sense of what a particular house might be worth in your neighbourhood, right. So based on its size, based on its location, and some of the visible features that you can see, so when you see an ad in the newspaper, for example, showing that the house is in the market for half the price that you would think is its fair value, you would deem that as a bargain and be interested in buying it.
And if you see a house in the same neighbourhood, with the same features exactly the same visible features that you can see, but you see, it’s in the market for twice the price that you deem as its fair value, then you would consider that way too expensive and you won’t be interested in buying it.
So in the same way, every currency will have a fair value based on what the market think it’s worth and finding out whether the currency is above or below the fair value comes down to the fundamentals and the sentiment, this is actually something that subconsciously, you would have done already knowing what a particular bias is for a particular currency pay.
Whenever you see the pay trading much higher than what you would compare at the, compared to its fair value would instinctively think that, hey, this thing is a little bit too high, or it’s a little bit too low, based on where you think it should be trading.
Now, in the same sense, fair value is basically based on the value that the market thinks it’s worth from a fundamental point of view.
But we could also use find useful areas on the chart itself with the price action has actually showed us what the market thinks is a currency pay’s fair value in the short term, and that is by just looking at the most recent swing highs in the swing lows.
So if we take a look at this Euro-US dollar chart, for example, we can see what the market is telling us. The market is telling us that in the short term, he deemed that this level at that 110 20, he deemed this as a fair value area to the upside in the short term, meaning when it reached that level sellers thought that, hey, this is a fair value to sell from and the chart is also telling us to the downside looking at this reason.
When the pay reached that level, we had buyers coming in saying that, “Hey, this is a fair value area for me to buy from.” So when we refer to fair value areas on the charts, we are basically just referring to the place on the chart where the market reacted from in the short term to either push the pay higher or lower, so in that sense, you can think of it as another way of looking at support, resistance areas or as swing points, nothing fancy, really just a helpful way of looking at the way markets have reacted at a certain price.
So how we can help, use this to help us in our trading is by knowing where the highest probability places is to look for bargain buys and bargain sells.
So if we see the market aging back to this overall zone, we would consider that a bargain to sell from, if we see aging back low into this overall area, we’d normally consider that a bargain to buy from.
Now, obviously, it is dependent on the sentiment and the fundamentals, so we’re not just gonna buy whenever it reaches the low and sell whenever it reaches the high, for example, we want a sentiment where fundamental reason to do that, and but it can also help us to establish when something is trading very cheaply, when something is trading very expensively. And it can also help us with our targets.
So if we are trading this to the downside, for example, this overall area, when we get close to this area, that is a good spot for us to reduce some risk before we reach the zone so just above that buy level.
And then, of course, just below that sell level would be good spot for us to put in any potential profit targets that we have for that pay on that particular session, so that is just a quick look at fair value areas and what exactly we mean when we refer to the fair value area on a particular currency pay.