Given that the currency market trades on $5.3 trillion in a day, exchange rates have the opportunity to fluctuate wildly. If you fail to keep an eye on where the market is headed, you could easily make a major misstep in anticipating the currency forecast.
Here are 3 ways you can project the currency forecast to ensure you make good trades and smart investments.
1. Purchasing Power Parity
There’s a common economic concept that states that things should have the same price, relatively, no matter where you go. When you buy an Apple computer in Japan, exchange rates and shipping aside, it should cost the same as it does when you go to buy it in the United States.
This is called a “One Price” law. If all goes as it should, it’s a good way to predict how exchange rates are going to act.
Combined with “One Price”, purchasing power parity accounts for inflation as well. Inflation is inconsistent between countries, so if the inflation in Japan is only 2% while being 3% in the U.S., that inflation difference of 1% would be considered in the equation.
If prices go up faster in Japan than in the United States, then the American dollar would need to depreciate by 1% to maintain a sense of parity.
This calculation can tell you how much you can anticipate growth.
2. Relative Economic Strength
Relative economic strength is a little more esoteric than PPP. It’s a way to get a general sense of the currency rates in a country and follows the economic growth of a country over time.
If one economy is stronger than another, logic would dictate that investors would become attracted to this country and its given currency.
When traders choose to invest in that country, they start by picking up some of their currency. When you buy their currency, it actually creates an increase in demand, as people see it being bought up. This then increases the currency rate.
You can see how you could manipulate currency quickly and change public perception artificially.
3. Models of Econometrics
This is the most complicated of all the theories. They’re based on strict economic theories, worked over by academics for more than a century.
In these models, you choose an economic factor that affects the currency then you create a model around it. If you think that GDP growth could be a good economic indicator, your model would then require you to multiply that by factors that affect exchange rates.
While you can factor in as many different concepts as you’d like, they, by and large, need to be based on real economic factors to make sense. Following the Currency Forecast Takes Focus
If you’re not a highly trained economist, casually checking the currency forecast could take some work. Studying these concepts is easy, but applying them to real-world models could prove to be the real challenge. However, there are no shortcuts to building sustainable wealth.
To get on the path to becoming a master trader, check out our latest guide.