These predictions are important because they help investors, brokers, and businesses make financial choices that reduce risk and increase returns. This is especially true in uncertain markets where economic conditions and exchange rates are constantly in flux.
Understanding Currency Forecasting
Currency forecasting allows companies and investors to predict exchange rates and use their funds effectively. Currency exchange rates are affected by many types of economic activity and are very dynamic, and as such, effective prediction methods are crucial.
Methods of Currency Forecasting
There are numerous methods of currency forecasting. All methods involve analysing key points of data. In each case, the accuracy of the method depends on the complexity of the approach and the expertise of the person or institution using the technique.
Some of the most well-known forecasting methods are:
Fundamental Analysis
Fundamental analysis involves monitoring macroeconomic indicators including interest rates, inflation, unemployment rates, and GDP growth. By monitoring this data, analysts can determine the strength of a nation’s economy and local currency in a mostly objective manner. The results can in turn be used to predict exchange rates.
Because fundamental analysis involves taking into account an economy in a broad sense, this approach can take into consideration more than just economic data. It may also consider political events such as election cycles, national policies, and international relations.
Additionally, fundamental analysis usually aims to track real-time events, meaning that it is necessary to take delays into account when collecting data and making predictions. Overall, fundamental analysis is complex but useful when carried out correctly.
Technical Analysis
Technical analysis involves observing past exchange rate data in order to identify recurring patterns and predict future events. Technical analysts typically rely on and create market charts — meaning that technical analysis is a highly visual approach to currency forecasting.
Measurements and tools that are often used in technical analysis include moving averages, oscillators, and momentum indicators. Technical analysts may also look for common chart patterns, including head and shoulders patterns, double tops and bottoms, and triangles.
Technical analysis is somewhat simpler than other forecasting techniques as it involves fewer calculations and mathematics. Unlike other methods, investors can attempt to use this forecasting method without the help of a professional analyst. However, the accuracy of amateur technical analysis and the quality of resulting predictions is questionable.
Econometric Models
Econometric models use mathematics and statistics to model certain economic trends. Specifically, this involves analysing historical data and relationships between variables.
Econometrics relies on well-defined models such as:
- The Purchasing Power Parity (PPP) model
- The Monetary Model
- Vector Autoregression (VAR)
- Artificial Neural Networks (ANNs)
Econometric models are highly complex and are often used by central banks and governments. Notably, the U.S. Federal Reserve relies on econometrics.
Market-Based Approaches
Market-based approaches take into account market expectations and sentiment among market participants in order to predict future currency fluctuations.
This is a broad category, and many types of analysis are contained within it, such as:
- Forward exchange rates, a measurement of expected exchange rates
- Options pricing, which analyses the price of currency options
- The Black-Scholes model, which makes predictions based on various factors including assumptions about risky assets and riskless assets
Market-based approaches may also involve collecting data from market participants through surveys. This may also involve monitoring forward exchange rates and options pricing. Once again, this approach is complex, and its accuracy relies on the quality of data used.
Factors Considered by Experts for Currency Forecasting
Each of the broad currency forecasting models described above addresses multiple factors that experts must take into account as they make predictions. Below, we’ll look at some of the factors that we mentioned above, but in greater detail.
Relative Economic Strength
Relative economic strength is a factor that compares the economies of different countries in order to forecast exchange rates. This approach presupposes that, if a country has a strong economy and a high growth rate, it will attract investments from other countries.
Foreign investments necessitate that foreign investors buy a country’s local currency; this increased demand should in turn drive up the price of the local currency.
Purchasing Power Parity (PPP)
Purchasing power parity (PPP) is one of the most widely used methods of predicting currency fluctuations. This is based on the “law of one price,” which suggests that any given product should have the same price in any country’s economy.
PPP also predicts that exchange rates will change to offset price changes resulting from inflation. If two countries see an item’s price fluctuate at different rates, each country’s local currency would have to gain or lose value at different rates to keep those prices equal.
This strategy can be applied to any product. For example, the Big Mac Index surveys the price of McDonalds’ popular hamburgers around the world. Each country’s ranking on the index determines whether its local currency is overvalued or undervalued.
Because individual products can be affected by the particular circ*mstances of a country’s economy, PPP is most effective when it takes into account a wide range of products.
ARIMA (Autoregressive Integrated Moving Average) Models
Autoregressive Integrated Moving Average (ARIMA) models predict future values from past values. More technically, ARIMA models can make use of certain information such as lagged moving averages or time series data to produce these predictions.
ARIMA models take for granted the idea that past economic events in some way indicate future events. This means that ARIMA models are not necessarily accurate in all cases, especially in circ*mstances where markets and political events are out of the ordinary.
ARIMA models are good for short-term forecasting but less effective for long-term forecasting. Though these models only require historical data, they are demanding in terms of computation, rely on subjective parameters, and may not predict all events.
Reserve Bank Announcements
Many countries make regular announcements through their reserve banks. In the United States, the Federal Reserve does this. In the UK, the Bank of England is responsible.
Though Reserve Banks do not usually set exchange rates directly, they may attempt to control inflation and interest rates. High interest rates can attract foreign investments, while high inflation rates can reduce foreign investment, in turn affecting exchange rates.
Combined with other economic and policy announcements, this information can be taken into account by analysts when they predict economic trends.
Government Stability
Government stability can have an impact on a currency’s value and relative strength. Countries that are highly stable usually have stronger currencies with more spending power, while countries that are less stable generally have less spending power.
Major countries and regions such as the EU, the United States, and China are typically seen as economic superpowers. As such, their currencies are almost always strong compared to developing countries, emerging markets, and countries with hyperinflation.
Political changes on any scale — from minor policy shifts to major elections and regime changes — can affect stability and can in turn impact the strength of a country’s currency.
Imports/Exports
The degree to which a company engages in international trade may affect demand for its local currency. This demand for currency in turn impacts exchange rates.
For example, a country that relies heavily on imports (and therefore exists in a trade deficit) creates little demand for its local currency, which likely weakens that currency. By contrast, a country that relies heavily on exports typically creates high demand for its currency among buyers — which in turn makes the country’s local currency stronger.
These trends can be taken into account by analysts through various forecasting methods, and by extension, imports and exports can be used to forecast exchange rates.
Capital Markets
Capital markets are financial markets that allow investors to trade stocks, bonds, currencies, and other financial assets. Analysts generally take news about capital markets into account when they make predictions about currency strength.
Furthermore, the forex market, which allows investors to trade foreign currencies, is a capital market in its own right. As such, forex trading affects exchange rates directly.
Economic Reports
Economic reports are published by governments and organisations around the world. These reports may contain data about workforces, immigration, education and skills, age demographics, income mobility, well-being, productivity, and other factors.
Combined with announcements from reserve and central banks, these reports are useful for any analyst that takes population-wide data into account for their predictions.
Conclusion
Currency forecasting can take into account numerous factors and can rely on countless different models. Some of these predictive methods can be practised by any investor. However, it is generally best to rely on professional analysts, as experts can take into account a large amount of information and perform advanced techniques on data.
Some companies and investors may choose to hire a financial analyst. Others may choose to rely on forex forecasting websites, media, and major newspapers — all of which employ a wide variety of analysts and provide free and paid access to their articles and data.
Regardless of your chosen source of information, currency forecasting is vital, especially if you are operating a business or making investments that are affected by global markets. Effective forecasting can help you use your money effectively, minimising risk and maximising returns especially when predictions are made with great accuracy.
Additional Resources
There are several online resources that can assist with currency forecasting, for example:
- FXStreet’s forex forecasts, rates and chats and analysis section
- The Wall Street Journal’s exchange rate page and finance section
- DailyFX’s home page and forex rates
- Bloomberg’s FX Center
- ForexFactory, which gathers news from across the Internet
- Investing.com, which publishes its own articles and articles from Reuters
- TradingView, which features charts as well as community analysis
- Reuters’ currency pages and charts
Investors may also choose to consult central and reserve bank pages, for example:
- The European Central Bank’s stats page
- The Bank of England’s stats page
- The U.S. Federal Reserve website
You may choose to hire a freelance analyst through sites such as Upwork and Fiverr. Hiring individuals listed on these sites is not necessarily equivalent to hiring a professional or corporate analyst. Be sure to check the reputation and qualifications of posters.
Finally, you can view the latest forex rates on the Payset website as well contact our support team for more information.
Together, these resources can help you stay on top of the latest forex developments.
