How Can You Forecast the Foreign Exchange Rate?


Quick Answer

Methods used to forecast foreign exchange rates include the purchasing power parity method, the relative economic strength approach, econometric models and time series models, explains Investopedia. It sometimes helps to combine all or some of the foreign exchange forecasting methods for a proper analysis of market and exchange rates.

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How Can You Forecast the Foreign Exchange Rate?
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Full Answer

The purchasing power parity principle is applied when the prices of the same items are compared in two countries or more, according to Investopedia. The country with the cheapest item indicates less inflation and a rise in the demand of its currency. The relative economic strength approach works on the principle that currencies of countries whose economies are growing tremendously are likely to rise in value when compared to those whose economies are stagnated or deteriorating.

The econometric models principle involves coming up with factors that may have the greatest impact on the growth of the economy and, consequently, on foreign exchange, notes Investopedia. Factors such as the GDP, income levels and interest rates, among others, can be compared between two countries, and a prediction of those countries’ currencies is then determined. On the other hand, the time series method uses past events to predict future economic occurrences and, consequently, help in forecasting the foreign exchange rate.

Investors use these methods to ensure they are able to significantly reduce losses and increase the chances of making profits, explains Investopedia.

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