Value investing enables traders to enter a forex trade by considering more than just its bullish price trend. It considers the overall value of a currency pair from a financial, economic and future perspective. Price increments due to unrelated events are eliminated, and more focus is put on investing in quality currency pairs.
In our article, we will discuss value investing in depth and how you can start it.
What is value investing?
Value investing is a trading strategy that focuses on investing in quality assets (currency pairs) that trade at a lower price compared to their true value.
The true value of a currency pair refers to its intrinsic value, which is the currency pair’s value based on its cash flow in the market and financial performance. It is the monetary benefit you receive by trading it.
Value investing focuses on investing in undervalued or oversold currency pairs with an expectation that the prices will go up in the near future.
- Traders buy the currency pair when the price of the currency pair is lower than its true value
- Traders sell the currency pair when the price of the currency pair is higher than its true value
Ratios to consider while value investing
Price/Earnings (P/E) Ratio
The P/E ratio helps analyse whether the currency pair’s current value is undervalued or not. It divides the currency pair’s price with its earnings per unit of the currency pair. This helps traders understand how much profit the particular currency pair is making in the forex market. A trader can compare the P/E ratio of several currency pairs together and decide which currency pair they want to invest in. A lower P/E ratio means that the currency pair may be undervalued, signalling traders to open more positions in the same way as their value investing strategy.
Dividend Yield Ratio
The dividend yield ratio can be used while trading stock, bonds or commodities CFDs as it indicates how much income is paid out every year as dividends to the shareholders as a percentage of its share’s price. Traders can calculate this ratio by dividing the yearly dividend by the asset’s current price. A high dividend means a higher income for the investor and vice versa, signalling them to open more positions with sites giving a higher ratio.
Price/BOOK (P/B) Ratio
The P/B ratio can also be used to trade share CFDs, as it measures the price of a company‘s stock against the company’s book value. It is calculated by dividing the company’s share price by the company’s book value. A company’s book value is the value of assets minus liabilities divided by the total share CFDs in the market. It helps investors understand the total amount they would get if the company were to be liquidated. The higher this ratio, the higher the value of the share CFD, signalling traders to invest in the same.
How to identify a value investing opportunity
1. Internal data
Traders can compare internal data with respect to the buying and selling of the currency pairs or CFDs to understand if any particular asset is undervalued. When an asset has more buying pressure than selling pressure, it indicates an optimistic growth opportunity for the same. This signals traders to open more positions in the same.
2. Peer-to-peer comparison
When traders compare two or more currency pairs together, they compare the value of one pair with another. This provides them with information as to which currency pair is more valuable, providing them with market entry signals. However, traders must always remember that peer-to-peer comparison needs to occur within peers, which means major pairs are to be compared with major pairs, minors with minors and exotics with exotics only.
3. Capital expenditure for share CFDs
When trading share CFDs, traders can analyse the company’s capital expenditure by researching if the company has any new projects lined up, expansion potential, funding and more. Details about capital expenditure help investors understand if there is a potential value growth for the particular share CFD. Higher the capital expenditure, the more the chance of the share CFDs to grow in value in the near future.
4. Wealth generated in the market
Traders can analyse how much wealth has particular currency pairs or CFDs generated in the market so far. They can compare the last ten years in growth or even more, apply technical analysis indicators and derive the future potential of the same. If an asset has generated positive wealth throughout the last few years, it is expected to continue doing the same, signalling investors to invest more in the asset.
How to start value investing
- After opening your trading account, analyse the different currency pairs and CFDs in the market
- Identify the currency pairs or CFDs with the maximum growth potential
- Apply different value investing strategies like selective trading (choosing an asset that has done better than the market in the last year) or buying the dip (investing in an asset that is trading at its lowest currently)
- Open a position in the asset that you believe is going to grow in value in the near future and is currently undervalued
- Monitor the market for any price fluctuations
- Exit the trade once the asset has increased in price and reached your take profit levels
Place your first value investing order today
Value investing strategies provide traders with long-term profits. It is used by big investors across the globe, like Warren Buffett and has not failed to provide successful results.