The traders in the financial markets forecast the currency exchange rate from time to time so that they can rely on these predictions for calculating the monetary value of a currency. There are various methods which support this forecasting. The article brings out the top trending ways for all levels of traders.
Approaches For Currency Exchange Rate Forecast
The two primary methods for forecasting currency exchange rate are as follows:
1) Fundamental Approach: It is the forecasting strategy which uses direct information related to a country such as productivity, unemployment rate, inflation rate, GDP and balance of trade. The main principle behind is, “true value” of a particular currency will finally be determined at some point. This type of approach is generally used for long-term investments.
2) Technical Approach: In this method, the trader sentiments decides the fluctuations in the currency exchange rate. It makes assumptions by drawing a chart of the trends and patterns. Along with this moving-average trend-seeking rules of trade, forex dealer’s customer-flow information and positioning surveys are used in this method.
Top 4 Models For Forecasting Currency Exchange Rate
Some crucial models for determining the currency exchange rate are:
1. Purchasing Power Parity Model
The PPP or purchasing power parity forecasting is a method which follows the principles of Law of One Price. According to this law, the same goods or products in different countries must have similar prices. For instance, this law demonstrates that a table in Africa will have the same price as a table of equal size and dimensions in the United States (considering the rate of exchange and excluding shipping and transaction costs). Thus, this will eliminate the arbitrage opportunity to purchase cheap in one country and sell it in another at a profit.
2. Relative Economic Strength Model
The relative economic strength approach defines the direction of currency exchange rates by making use of growth and the strength of the economic development of various countries. The basic idea behind this model is that the economic development of any country will automatically attract more foreign traders to invest in the country. To buy these investments in a specific country, the traders will purchase the country’s currency. It will result in an increment in the price and demand and eventually appreciate the value of the currency of that specific country.
Another factor which will play an essential role in bringing traders or investors to a specific is its rates of interest. Higher the rates of interest the more it will attract the investors, and with this, the demand for the currency will surge, which will eventually appreciate the currency.
Unlike this, the low-interest rate will compel investors not to purchase or invest in a particular country. The trader may even borrow its low-value currency for funding other types of investments. It was the case when yen interest rates fell below a level. It is generally known as the carry-trade strategy.
3. Econometric Models
It is a model which can be used for forecasting currency exchange rates by collecting all the required relevant factors which might affect a particular currency. It extracts the essential information from these factors to generate the result of the forecast.
4. Time Series Model
The Time Series approach is entirely technical and does not accommodate any economic theory. This famous model is also known as the ARMA process (autoregressive moving average).
The basis of this model is that the price patterns and past behaviours can significantly affect future’s pattern and price behaviour. The information used in this method is the time series of data which is used to choose parameters for creating a workable model.
The Bottom Line
In the end, one can say that forecasting the currency exchange rate is a hard task, and it is the reason why several investors and firms tend to hedge only the currency risk. Still, some people do not believe in the hardship involved with the task; they just need better and profitable results anyhow. These people can use any or all the methods listed above.
For starting your trading journey in the currency market choose for the right broker. The choice of the right broker itself cut half the risk and other trade-related problems. Two leading names in the list of brokerage firms are T1markets and TradeATF.