Foreign Exchange Forecasting Methods

The ability to predict currency conversion rates is a valuable skill in business. Such predictions enhance the accuracy of financial projections and help businesses budget with greater confidence. Utilizing different techniques of forecasting exchange rates helps any company doing business in multiple countries arrive at better results.

Technical Analysis

Technical analysis is a broad term encompassing all forex forecasting techniques that rely on the price and volume history of a particular currency to predict its future value. The analyst may, for example, analyze the past pattern of the euro/dollar exchange rate, looking for such formations as triangles, boxes and resistance levels in the price graph, according to Earn Forex. Each formation makes a particular future price move more predictable, as such formations signal positive or negative investor sentiment. The trading volume holds further clues, either confirming or calling into question the assumptions arrived at through price patterns alone.

Macroeconomic Analysis

Macroeconomists track broad economic indicators. When trying to determine the future exchange rate between two currencies, the economist also must understand economic fundamentals in both nations, according to IG. Inflation levels, economic growth prospects, political dynamics, and central bank policies are among the most important factors in influencing currency movements. As a broad rule, the more prosperous a nation, the more valuable its currency will become. Economic weakness, especially if combined with high inflation, results in a weakening of the currency.

Investor Surveys

The price of any asset, including currencies, ultimately is determined by supply and demand. Therefore, the most direct method of predicting future exchange rates is asking investors how much of each currency they plan to purchase or sell in the near future by way of investor surveys. Unfortunately, big investors may not always wish to disclose their intentions.

In addition, not all investors have a long-term investment plan. Instead, some buyers and seller vary their strategies depending on the constant stream of economic news and price fluctuations. However, investor surveys do have a place in the analyst's arsenal as a valuable complementary tool.

Cross-Currency Rates

Another way to forecast the exchange rate between two currencies is to compare their respective exchange rates versus a third currency. For example, an analyst may be interested in the British pound versus the Japanese yen exchange rate. For further insight, the analyst may zoom in on the pound versus dollar and yen versus dollar rates.

This method of using three currencies to calculate the expected exchange rate between two of those three currencies is called triangulation. If a gross discrepancy exists between the actual rate and that predicted by triangulation, traders could make an immediate profit by executing a series of conversions using those three currencies.