Currency Exchange –An Insight

There is no definitive method available to forecast currency exchange rates as, theoretically, the economic fundamentals of a country play a major role in determining the value of its currency. Interest rates, inflation rates and national income in a country, act as different forces on trade and capital flows, thus affecting the demand and supply of the currency.

But over the time period, there have been instances when the foreign currency exchange rates have moved contrary to these fundamentals during lengthy periods of time. However, it has been seen that any attempt to use empirical models to test economic fundamentals to calculate currency exchange movements have not been very successful.Market practitioners have been successfully trading forex with profitable trading strategies, developed and implemented by them but not based on any of these economic fundamentals. Professionals of currency exchanges believe the behavior of traders in the forex market can force an exchange rate to move away from its fundamental value, thus establishing a currency position that becomes profitable.

To gauge the degree to which economic fundamentals can influence the trading behavior of forex traders, various surveys have been done. These surveys are a valuable source of information on the factors which influence traders and hence the exchange rates currency.

The responses in these surveys throw light on various factors, which are of relative importance to the forex traders in order to trade profitably. This information may identify areas other than those previously studied and provide additional explanations for exchange rate movements. The use of electronic broking, bid-ask spread size and the degree of competition in the market are also considered important factors in the market's trading environment.

While the debate on currency rate exchange determination will continue, as mentioned before, economists do not possess any reliable methods of calculating currency exchange rates over short time periods like days or weeks. Market sentiments to change as financial news can change the outlook on a country's economic prospects.

Surveying the track record of many popular forex exchange rate forecasting companies, there is little evidence to support that professional forecaster does better than an individual using the three month forward rate. But this does not mean that forward rates are good predictors, for they usually do not predict currency exchange rates movements very well.

As a conclusion, it is safe to say that the long term movements are based on fundamental forces, while the short term exchange currency rate exchange movements are driven by news and events.