When you start trading in the forex market, there come many economic theories that affect the forex market trade.
It is extremely essential for an investor to understand the economic theories that may affect the trade market, in order to run smoothly and get a safe side to properly participate in the trade.
Here I am explaining the two most essential theories of Economic that affect the Forex trade market.
Theory #1 Balance Of Payments
Balance of Payments is a method that companies are using in order to record international trade transactions. In simple words the recording of the amount coming in and going out of the country.
The BOP is recorded quarterly and yearly, it is not only the transactions of public companies but both companies are bound to record their international trade transaction, either coming in or going out of the country.
The transactions are recorded on a general ledger, used to record the financial transactions, when a country has given more money the transaction is recorded on the debit side of the general ledger and when the company has received money it is recorded on credit side of the general ledger.
Generally, the BOP looks more on current accounts, rather than the capital accounts, BOP gives the signals of currency that in which direction the currency Is heading if we are selling more currency it means people outside our country using more our currency to buy goods and services or to do investment in our country, this increase leads to the high demand of our currency in the international market, and according to the economic demand law, “higher the demand higher the price” our currency value will increase.
Theory #2 Purchasing Power Parity (PPP)
Purchasing Power Parity works on the law of one price. This theory is working on the notion that if there would have no transaction cost, trade barriers, and tariff so the price of one good must be equal to another good, it means if a lab top is costing $500 in the USA so it must be in the same price in the UK.
PPP theory is not accounting a single good because it will be difficult to manage the cost and trade barrier issues for one good, bit PPP accounts for a basket of Goods in Purchasing Power Parity Theory.
The main idea behind this Purchasing Power Parity Theory is that the proper exchange rate must be used in order to get the same rate for the same commodities in different locations.
PPP theory states that the FX market moves towards its fair value in the long run by affecting the exchange rate.
The theory states that currency value asserts the risk factor that varies across the countries but is static over time.
The above theories are Economic theories but they both affect the exchange rate and forex market, if not directly but, indirectly they and there are some other theories that affect the forex market.