Currency Forecasting
As the name suggests, currency forecasting refers to the ability to predict the long-term value and price of a currency. We have seen that there are, at least, two approaches to predicting price changes. The first is fundamental analysis . The second is technical analysis . However, technical analysis is more useful for developing trading strategies that predict future price movements.
Market conditions are not an important factor to technical traders. Fundamentalists are typically attempting to forecast market behavior and then predict how a currency will respond in such a market environment. To do so, fundamental traders develop models from which to formulate a trading strategy. Technical traders skip directly to developing a trading system.
Currency Forecasting Models
Fundamental traders will use models to examine currency values. (Remember, technical traders do not employ this method, but rather use trading systems .) This method of developing models of currency forecasting is used by analysts of major banks and financial institutions to examine market conditions and forecast currency values. There are basically seven major models for forecasting currency prices. They are:
- Balance of Payments Model
- Purchasing Power Parity Model
- Interest Rate Parity Model
- Monetary Model
- Real Interest Rate Differential Model
- Asset Market Model
- Currency Substitution Model
As you can see from the names, the models analyze different aspects of economic and monetary conditions. In fact, many traders joke that these are the models that bookworms use to predict the price changes of currency pairs. These traders are looking to predict the long-term outlook of currencies.
Level of Difficulty
Using trading models is not easy. In fact, they can be quite difficult. They require that the trader examine many economic reports very closely. Getting the figures is not enough when using these models. You must get behind the figures, read the reports closely, and analyze their meaning. In other words, you must read more than the headlines! It can be difficult and time-consuming, but also rewarding.
Caveat
Many traders who use trading models get seduced by the information. They begin to analyze the numbers for the mental stimulation they provide rather than to predict currency values. They suffer information overload and succumb to the “paralysis of analysis.” Beware of this phenomenon. Focus on what the information can do for you rather than on collecting the vast amount of information available.
