We have said time and time again that the forex market is a volatile place. And making sense of this chaotic space is a task that every trader has to take up. Forex forecasting means using any available means or resources to predict the market trends. Essentially, it is speculating market movements but based on economic data and facts.
As we discussed previously, fundamental and technical analysis are the two most common techniques utilized by traders to anticipate exchange rates. Even if the process involved with both the methods vary, inherently they perform the same function of helping traders understand how rates could affect the trading of a particular currency pair.
The fundamental analysis makes use of a country’s GDP, unemployment rates, etc. to forecast exchange rates. As for technical analysis, it’s all about using price history and trends to predict future rates. Whereas, for forex forecasting methods there are mainly four that make the cut; PPP model, relative economic strength, time series, and econometric.
The first one, PPP or Purchasing Power Parity is rooted in the Law of One Price, which states same goods in different countries could have the same price. The price of the goods takes into consideration the exchange rate but excludes shipping, storage, and transaction costs. As per this method, the exchange rate will adjust to offset the prices of the goods.
The relative economic strength method theorizes that a country with strong economic growth will attract more foreign investors thus could increase the demand for their currency. Thus the demand for the currency could eventually lead to its appreciation. Consequently, relative economic strength helps to determine the appreciation and depreciation of a currency.
The econometric models approach is using factors that affect the currency market the most, to create a model that relates to its exchange rate. The factors utilized in econometric models such as GDP, interest rate differential, and so on are usually based on the economic theory. But any aspect relevant to a country’s currency can be added to this model.
Lastly, the time series model is completely technical in nature. This approach is based on the idea of using prior price patterns and behavior history to speculate possible future price movements.
While there are numerous tools and techniques to forecast forex, it’s still a humungous task. That’s why apart from speculating price movements traders also make use of risk and money management methods to cut down their losses when they get it wrong. Regardless, incorporating your understanding of forex forecasting into a trading strategy can help to see the big picture and thus make an informed trading decision.
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