Understanding inflation

What is inflation

A few years ago when you were a child, your parents carry you to the supermarket and you all did bought foods stuff that weekened. Now you have grown up you realize the value of those goods and service has increased. This is what you called inflation. It is the general increase of goods and service over a period of time.

What causes inflation

There is no one answer to what causes inflation but we know it can effects every country. Therefore, every business owner has the responsibility, to take into account various the factors that causes inflation and how does it affect there business.

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Trading and inflation

In spot forex, inflation is one of the most important economic indicator that traders must pay attend to before entry a trade. There are some cases in trading were inflation is good. If you are trading spot forex who has gone short on EUR/CAD and the Euro is hit by a very high inflation, you will make a profit, if the CAD are not experience the same, as the value of CAD dollar will riase against the euro. Here we can see a high inflation will not attract investors in this case, in which it slows down economic growth, giving that currency less purchasing power. Therefore forex traders needs detailed knowledge on inflation which helps you to make your forex market trades profitable.

High inflation

A high inflation does not always mean that a country is not growing, inflation is what a country is looking for after an economic crisis. Inflation sometime means that people have money and they are willing to spend it. When inflation goes up, the price of goods and services goes up. For example, when gas prices goes up it affect nearly most every other business. It can be good and in some cases it can be bad.

Most countries are not looking for a high inflation rate, the rate these first world countries are looking for is around 2%. High inflation create uncertainty for business owners and Investors. In the Forex market, for example lets say you have the CAD/USD. If the Canadian county is hit by a high inflation, importing oil will get more expensive for the US. This can lends to Canada becoming more expensive to do business and can cause Investors to put there money else where. In the long term it will slow down the growth of the country.

When inflation goes up, consumer prices goes up and it’s currency loses purchasing power. In spot forex, let say you have the CAD/USD pair and Canada inflation goes down. The trader who takes a long position well make a profit. Because Canada currency purchasing power goes up when inflation goes down. Therefore, traders will look at these economy indicators of both pairs, look at the inflation rate and see which direction interest rate is going, so they can buy or sell a particular currency.

Interest rate

Interest rates and inflation normally move in the same direction. Banks use interest rate to control inflation. When inflation increase, Banks increase interest rate. This cause the demand for goods and services to reduce. The inflation rate in the U.S., is measured by the Consumer Price Index, was 8.5% in July 2022. This means the costs of goods rose by an average of 8.5% year-over-year.

higher interest rates mean it’s more expensive to buy goods and services such as cars, house or furniture items. Am increase in interest rate , would cause a higher annual percentage rate on your credit card or a higher annual percentage yield, or on your savings account. Therefore, consumers who has debt on their credit card could see higher interest charges on their monthly statement.

In the U.S., the Federal Reserve main function is to maintain a low inflation rate and unemployment rate, they does this by controlling interest rates. So here we see interest rate can affect a country currency to the point forex traders need to pay attention to is economy indicator.

Interest Rate Differentials

What is interest rate differential? Interest rate differential is the difference between two interest rate, of two different countries. Most forex traders uses this technique of comparing one currency’s interest rate to another currency’s interest rate to find out whether a currency may weaken or strengthen. There are time when two interest rate of two different countries are moving in the opposite direction. This however creates a large swing in the market. So traders can decide if they want to bull or sell a particular currency. This is a good fundamental analysis for forex traders.

Currency Conversion

What is currency conversion? Currency conversion is the exchange of money from one currency to another. Beside from the factors such as inflation and interest rates that we talk about perviously, the currency exchange rate of a country, is the pulse of the country economy growth. A high currency exchange rate makes a country’s imports less expensive and its exports more expensive.

In most cases a country is looking for a good exchange rate, to the point where export exceed import. This in return will cause growth. In spot forex, when it comes to exchange rate between two currency, traders are looking for higher rates to invest in. If a particular currency is falling, traders would sell that currency.

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Concluding

When we are looking at inflation from an fundamental analysis aspect, there are many factors we need to take into consideration. Because there are other fundamental analysis that overlap this subject, that is critical in making good trading decision, not only for day trading but for long term investment.

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