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According to the "Purchasing Power Parity" or PPP theory you may evaluate the true relationship of two currencies based on the purchasing power in their home countries. For example if you can purchase a TV set for $3000.00 in the United States and the same TV set for £2000.00 in the United Kingdom then the actual ratio of GBP/USD should be 1.5000 or rather 3000/2000. Now if the current price of this pair is 1.3000 then we should expect an increase in the price toward the 1.5000 ratio.

You may use a specific product or a basket of products to make such calculations. When you compare goods you need to consider those goods that our available in both nations.

One interesting method of comparison that is apparently offered by "The Economist" is using the price of McDonald's Big Mac for such calculations. For example if a Big Mac sandwitch is sold for an average of €7.60 in European Union countries and $5.00 in Canada then EUR/CAD should be 1.5200. Now if the current ratio of EUR/CAD is 1.6000 then we expect depreciation of this price in the future.

While this analysis cannot be of much help to a typical forex trader - especially scalpers and day traders - but it could be used to find out the long term future movements of the currencies with respect to each other. Even if it is not worth trading it would be interesting to analyze the market the burger way or as The Economist call it with the help of Burgernomics.

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Risk Warning!

Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.
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