Can You Predict FX Rates?

Posted by admin 28/10/2013 Comments are off 818 views

Predict FX Rates

This article looks at two methods you can make use of to predict FX rates.

One of the wishes on a forex trader’s wish list is to be able to find a perfect system for the prediction of FX rates.  There are so many factors you have to take into account to effectively undertake this task, but you have several methods at hand to do it.  The methods vary in popularity as you need to find the one that best suits your trading plan and personality.

PPP (Purchasing Power Parity)

If you search for a method to forecast FX rates, purchasing power parity is the model you will come across in most economic textbooks or papers.  This method is based on the principle of the Law of One Price.  The law says that identical items should cost the same regardless of the country where it is being sold.

It states that a basic commodity should bear the same cost in Australia as it does in the US.  The cost has to be calculated by factoring in the exchange rate variance, but with the exclusion of the costs for shipping and transaction fees.  This will eliminate the possibility of an entity purchasing the standard item in one country and deriving a profit from the sale of it in another country.  It is also necessary for an adjustment to the cost based on the price variance due to the inflation rate variance.  For example, if the price was to increase by 4% in the US and by 6% in Australia.  This means that the inflation rate variance between the two countries is 2% which indicates that Australia will experience a quicker price increase.  To make use of this model, it means that the Australian dollar should be decreased by 2% to obtain parity in the prices of the two countries.

FX Rates and Econometrics

This method requires that you obtain information and data you feel may have an impact on currency values.  By collating the gathered data, along with other factors that you think will affect the rate, you should have sufficient information to devise a model to aid you in predicting the FX rates.  It is best you use sound economic theories with the variables you think are relevant and could affect the value of the currency.  An example of this method is if you believe that the differential in interest rates, along with the gross domestic product growth between your currency pair will be affected.  In this case, you should factor in these variables to acquire a suitable forecast method.

This can become quite a time consuming and complicated calculation.  This is because you have to consider additional factors to your method of calculation.  This method is unsuitable for traders with limited time.  The main advantage to this method of calculation is that once you have devised a suitable model all that is required is to add the variables to do the prediction.  You can quite easily do this if your method of calculation is sound.

These are not the only two methods you can use to predict FX rates.  There are several other methods and you should find the model that best fits in with your trading plan and strategy.




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