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We recommend that you seek independent advice and ensure you fully understand the risks involved before trading. Get Selected Guides 0. How to Trade. Popular topics Forex. Showing 0 of 34 guides Show all. No matches found for these criteria. Using a currency exchange rate forecast can help brokers and businesses make informed decisions to help minimize risks and maximize returns. Many methods of forecasting currency exchange rates exist. Here, we'll look at a few of the most popular methods: purchasing power parity, relative economic strength, and econometric models.
The purchasing power parity PPP is perhaps the most popular method due to its indoctrination in most economic textbooks. The PPP forecasting approach is based on the theoretical law of one price , which states that identical goods in different countries should have identical prices. According to purchasing power parity, a pencil in Canada should be the same price as a pencil in the United States after taking into account the exchange rate and excluding transaction and shipping costs.
In other words, there should be no arbitrage opportunity for someone to buy inexpensive pencils in one country and sell them in another for a profit. The PPP approach forecasts that the exchange rate will change to offset price changes due to inflation based on this underlying principle.
To use the above example, suppose that the prices of pencils in the U. The inflation differential between the two countries is:. This means that prices of pencils in the U. In this situation, the purchasing power parity approach would forecast that the U. So, if the current exchange rate was 90 cents U.
Meaning it would now take 92 cents U. This lighthearted index attempts to measure whether a currency is undervalued or overvalued based on the price of Big Macs in various countries. Since Big Macs are nearly universal in all the countries they are sold, a comparison of their prices serves as the basis for the index.
As the name may suggest, the relative economic strength approach looks at the strength of economic growth in different countries in order to forecast the direction of exchange rates. The rationale behind this approach is based on the idea that a strong economic environment and potentially high growth are more likely to attract investments from foreign investors. And, in order to purchase investments in the desired country, an investor would have to purchase the country's currency—creating increased demand that should cause the currency to appreciate.
This approach doesn't just look at the relative economic strength between countries. It takes a more general view and looks at all investment flows. For instance, another factor that can draw investors to a certain country is interest rates. High interest rates will attract investors looking for the highest yield on their investments, causing demand for the currency to increase, which again would result in an appreciation of the currency. Conversely, low interest rates can also sometimes induce investors to avoid investing in a particular country or even borrow that country's currency at low interest rates to fund other investments.
Many investors did this with the Japanese yen when the interest rates in Japan were at extreme lows. This strategy is commonly known as the carry trade. The relative economic strength method doesn't forecast what the exchange rate should be, unlike the PPP approach. Rather, this approach gives the investor a general sense of whether a currency is going to appreciate or depreciate and an overall feel for the strength of the movement. It is typically used in combination with other forecasting methods to produce a complete result.
Another common method used to forecast exchange rates involves gathering factors that might affect currency movements and creating a model that relates these variables to the exchange rate. The factors used in econometric models are typically based on economic theory, but any variable can be added if it is believed to significantly influence the exchange rate.
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Forex forecasting software refers to computer-based technical analysis software geared to currency markets. · The goal is to automate identification of technical. Currency exchange rate forecasts help brokers and businesses make better decisions. Purchasing power parity looks at the prices of goods in different countries. In order to forecast future movements in exchange rates using past market data, traders need to look for patterns and signals. Previous price movements cause.