Currency rate forecasting is a fundamental activity for a Forex trader.
Factors That Affect a Currency Rate:
· Government Stability
For example, wars lead to the depreciation of a domestic currency, while presidential elections may cause increased price volatility.
· Economic Reports
A growing economy indicates opportunities for appreciation. Conversely, economic problems will lead to a currency’s decline.
· Central Bank Monetary Policy
When the central bank raises the interest rate, the domestic currency usually appreciates. When it cuts the rate, the country’s legal tender usually depreciates.
Ways to Predict Exchange Rates
1. Fundamental Analysis
This forecast method includes monetary policy, domestic and foreign government policy, and global economic and political conditions.
2. Technical Analysis
This approach uses patterns discovered from historical price data and statistics to forecast future movement. Indicators, trendlines, and candlestick and chart patterns are essential instruments of technical analysis.
3. Relative Economic Strength
Many economic factors make up FX rate forecasts and these factors also interact with each other. For example, a country’s inflation or unemployment rate can give traders an idea of what its monetary policy will be like.
4. Econometric Model
This FX rate forecast method is personal, as it differs between traders. Comparing economic conditions in two countries, traders could forecast an exchange rate. By determining differences, they may predict the direction of a pair’s rate.
5. Purchasing Power Parity (PPP)
This method asserts that the price of goods and services should be equal, regardless of the country. If there are any differences in price, a trader can calculate the suitable exchange rate that will make goods or services cost the same. Knowing the required exchange rate, traders might determine whether a currency is overvalued or undervalued. With this, they can make a guess at future currency values.
6. Interest Rate Parity (IRP)
IRP focuses on currency and interest rates. The main idea: the differential between interest rates should equal the differential between spot and forward exchange rates.
The Interest Rate Parity method implies the following formula:
- F0 = Future exchange rate
- S0 = Current (spot) exchange rate
- ia = Interest rate of the country of the quote currency
- ib = Interest rate of the country of the base currency
A trader should calculate the current currency pair rate and the interest rates of both countries to determine the future exchange rate of a currency pair.
7. Balance Payment Theory
This foreign exchange model determines future currency values by considering a country’s rate of imports and exports: the domestic currency appreciates when it exports more than it imports and depreciates when the opposite occurs.