What Is Fair Value, Really?

What is fair value?

• The macro fund looks at some oil miner and reckons that on the earnings growth coming, it’s worth $20 a share more than it’s trading at right now.
• The high-frequency quant guys think there’s a one-tick arb across the futures and the ETF. Fair value in the next millisecond is one tick higher. So they take it thousands of times a day.

What’s it actually worth, and is the current price wrong?

So what about us?
The typical 5m, 15m, 1h trader.

We see the DAX put in a higher low, and that’s the trigger; in we go.

The pattern showed up, and so we took it… And sometimes that’s fine.

But… we never said what we think it’s worth.

Here’s the same trade with that question bolted on.

DAX is trading at 25,785.
You reckon fair value in an hour is closer to 26,300, and you’ve got a reason why.

Now, when that higher low forms, the pattern isn’t the reason for the trade… It’s just the trigger for a trade you already believe in.

Ok, so how do you decide what ‘fair value’ even is?

A couple of ways to consider…

Momentum. The flow is so one-way, so relentless, that you think it settles a lot higher than here.
Fair value is up there somewhere, perhaps the next key level; the market just hasn’t caught up yet.

Mean reversion. It’s been stretched way too far one way. Overdone, you think the snap back is coming.
Fair value sits well above where it’s currently sitting. Perhaps a VWAP.

Neither is perfect, of course, but either way, you form the view first, then you wait for the trigger to time you in.

Now… this isn’t some silver bullet. This won’t change your win rate by Friday.

But it gives you one question to ask before you allocate risk.

The chart says go… but do you actually believe this market is mispriced right now?
Or is it just a textbook pattern jumping out?

Because if the honest answer is “nah, it just ticks the pattern box”… that might be a trade you should pass.

As you develop and grow, you start to realise that trading is not just about chart patterns anyway…

It’s buying something you think is underpriced and selling something you think is overpriced. (Don Miller used to call it buying wholesale and selling retail “I’ll almost always readily take a wholesale”.)

Probably needs some unpacking, but worth digging into, if it resonates…

After all, if it works for funds that spend loads figuring this stuff out, it’s probably worth modelling!