Value based investments

Value investing could quite possibly be one of the most successful investment strategies of all time... But it was designed and created for stocks..

Is there an equivalent that can be used to invest in currencies?

Value Investing - The strategy of selecting stocks that trade for less than their intrinsic value. Value investors actively seek stocks of companies that they believe the market has undervalued. They believe the market overreacts to good and bad news, causing stock price movements that do not correspond with the company's long-term fundamentals. The result is an opportunity for value investors to profit by buying when the price is deflated.

Typically, value investors select stocks with lower-than-average price-to-book or price-to-earnings ratios and/or high dividend yields.

at first thought it seems that the primary difference would be that you are observing one currency against another directly, rather than, say, discounting future earnings of a business vs its present earnings. we see people buy/sell on dips/rallies because they believe that price will return to at least a previous level after some shock or endogenous flow—is that value investing of a sort? or are you looking for more of a price/per capita GDP type of ratio to monitor?

Yes, it's called macro-economics. Unfortunately economists themselves disagree substantially, and when they really trade their theories in the market they are as likely to blow up substantially (think LCTM, run by a couple of Nobel prize winners) as they are to profit (IIRC, Friedman did very well on the markets).

more of a price/per capita GDP..

i use value-investing in my virtual stock trading. however, i do not think it can be applied in the forex market. in order to do some sort of value-investing in forex, you should know macroeconomics and monetary policy like the back of your hand.

It's called buying dips and selling rallies in a trendy pair where speculation plays an effective role (usually the majors).

And yes, it is an extremely effective way to make money, as many will attest. Even better is to be able to know how far speculation can go before the price becomes too over/undervalued and the market begins to reverse..it's an art, and it can make you as rich as..say..Soros

If you are looking for a simple measure, just use the difference in bond yeilds. Bond money flows much faster than (say) commodity money, so in the short term FX is often domiinated by it - and more particularly rapid changes to it The basic approximating equation is:

price velocity
------------ = (home interest rate) - (foreign interest rate)
price

with price being denominated as units of foreign ccy/unit of home ccy. Lots of other thigs to take into account, however; the big thing to remember is that ccy relations between states are much more dynamic than (say) stocks.

If you agree with me that gold and silver are considered currencies in a way or another, then the best value investing would be buying gold and silver on dips.


Thanks,

Nader

This is a great question - one I've often asked to myself. I've concluded that a value investing approach would be pretty difficult in FX given 1) it is hard to determine the intrinsic value of one currency vs. another currency, and 2) there is a significant difference between investors and speculators. Let me talk about each one of these points individually.

First, your definition of value investing is pretty straight-forward. I work with a number of mutual fund portfolio managers who follow a "value" approach to stock picking (as opposed to a "growth" stock method). Value stocks are "on-sale" meaning that the manager thinks that in a fair and equal world XYZ stock should be selling for $25 per share while in our real world it is going for $18. Depending upon the tolerances of the manager, XYZ may or may not be a good value buy. Some managers may want to see the price of XYZ go even lower into the $12-$13 dollar range before considering it a buy. Whatever the case, there are specific methods that these value managers use to determine what the price "should" be. Discounted cash flows, price-to-book, etc. In any event, the stock is deemed to be a "good pick" if it is trading significantly below where the manager values the company's share price.

How would we do this with currency? We would have to forecast interest rates, GDP numbers, payrolls, durable goods orders, Treasury security auctions (if trading USD pairs), wages, inflation, etc. This is somewhat more daunting than forecasting earnings of a single firm. The Federal Reserve Board of Governors has difficulty doing this and they are some pretty smart people who went to some damn good schools and had some really important jobs and lots of experience before setting the monitary policy of the largest free market economy in the world. In addition, you'd have to take into account any manipulation by central banks in the markets as well (i.e. Japan) In short, it is much easier to value a company based on their published financial documents and compare that to the share price in order to determine if there is a value play or not.

Second, value investing is different that currency speculation. I would argue that investing in a stock is quite different than trading a stock. Likewise, trading currencies is different that investing in them since you're SHORTING one currency and BUYING another in the retail FX world. You may have to hold that trade for a long time, and 100:1 leverage would be considered suicide to a long-term investor. If you stepped the margin down, your potential return decreases. Or you may have to go to a bank and buy Euros for your dollars, in that case I doubt you will be given any margin at all. Sooner or later, I'm guessing that you'd be down to around the same margin used for trading stocks (1:1 or 2:1) in order to justify the length of time involved with a currency investment or to deal with the practicality of investing. At that point, wouldn't you save yourself some time by valuing single stocks vs. currencies for a similar return? Why do more work and get paid the same amount?

Finally, I also want to point out that I believe value investing is more than just "buying-on-dips". The effect may be somewhat the same, but the process is entirely different. While it is common for value stocks to be bought below their previous highs, this doesn't have to be the case. A stock might be trading at its all-time high of $10 per share and still be a value buy if you look over the financials and compute that it should be trading at $17.50 and is in an industry that has been beaten down lately. Granted, this may be more of a growth stock, but depending upon the context the example works. In short, the value investing approach has nothing to do with analyzing a chart or comparing current price to previous prices. Buying-on-dips is just that, comparing where price is now to where it was previously - that has nothing at all to do with valuation.

Hopefully this helps. I don't know how effective applying value investing techniques will be to FX trading.

I just wanted to say that one reason value investing is popular, at least with many investors, is because there is a "cushion" involved. If you're wrong about the direction of the stock, at least you didn't buy it when it was very high. You're trying to buy a stock at a hefty discount, if you're wrong about the price appreciation, you "bought low" and when you get out of the trade you've "sold low". This is the way that value investing helps deal with uncertainty in markets - it lessens the blow when you're wrong.

If it is certain that gold and silver are going to go up, why wait for a dip? Obviously, if they're bound to go up, they're a value play right now. Just playing price isn't value investing. A value manager knows what s/he thinks the asset should be valued at and knows at what price s/he wants to buy the asset for. What should gold be valued at? What price would gold be a good value play? If you don't clearly know these two things and have the analysis to back it up, then you're not investing with a value approach. You're speculating on price appreciation.

Not that I don't speculate mind you, I think speculation is more profitable than value investing. Rarely do I ever have a remote guess about what a currency "should" be valued at. I don't really care. I'm speculating on a short-term direction using a mostly-naked chart. If I'm going long a pair, for instance, I want price to increase whether or not the "true" valuation is higher than current price or lower. Nothing value-oriented about that hehe!

-=DAVE=-