How to Use Fibonacci Expansions

A concept I always teach is the importance of using support and resistance levels to decide when to get out of positions. Just like getting a good entry is important for a successful trade, you must also ensure you are exiting your trades at levels that maximize your gains. This article aims to assist traders in finding profit maximizing exit levels using Fibonacci Expansions.

What are Fibonacci Expansions?

Fibonacci Expansions are price levels created by tracking a price’s primary move and its retracement. The resulting price levels are then drawn on the chart in an area that would normally be difficult to gauge support and resistance using ordinary charting tools. This makes Fibonacci Expansion especially useful for picking profit targets when trading trends.

When faced with an upward trending currency pair, there are going to be times when price temporarily moves counter to the trend. We call these moves pullbacks or retracements. Once this counter move is exhausted, price resumes back in the direction of the primary trend and often times will break to new highs. It is at that moment, that Fibonacci can be used.

While the familiar Fibonacci Retracements are used to determine how far the price might originally retrace, Fibonacci Expansions can help us determine where price might head after the retracement is exhausted. On the EUR/USD daily chart below, I have highlighted a primary move followed by a retracement move.

Learn Forex: Simple Moving Average Crossover (With Trend Filter)

Now that the Fibonacci Expansion has been selected, we will need to select three price points to setup the tool properly. We will click a total of 3 times on the chart at the following price levels, in the following order.

1.    The beginning of the primary move, the low.

2.    The end of the primary move, the high.

3.    The retracement, the swing low.

After clicking OK, we should see several horizontal lines projected on the chart.

Learn Forex: Drawing and Reading the Fibonacci Expansion

How Do You Interpret Fibonacci Expansions?

This particular example on the EUR/USD daily chart is utilizing the more popular 0.618, 1.000 and 1.618 expansions. (There are also optional expansions at the 2.618 and 4.236 levels that you could add). All these lines can be considered resistance levels as the price trends higher, making them perfect areas to place profit targets.

We can see that price quickly hit the 1st profit target before consolidating, and then later broke upwards towards the 2nd profit target before retracing lower. It hit each of these prices on the nose before price regrouped for its next move. This gave us some spectacular exits for a long trade. If we remained a EUR/USD bull, our next target would be right below 1.4250 (at the 1.618 Fibonacci Expansion).

Scaling out of a trade with multiple targets is an effective money management strategy allowing you to lock in profits as the position matures. Just like diversifying your portfolio can help smooth out your overall returns, having multiple profit targets smooth out your returns on a trade by trade basis.

Finishing With Fibonacci

Once you add Fibonacci Expansions on a few of your charts, it becomes second nature to project these support/resistance lines for all your trend trades to assist with your profit targets. It also accompanies the Fibonacci Retracement tool nicely since the Fibonacci Retracement is traditionally used to get good entries on pullbacks from an existing trend.

How to use Fibonacci Retracements

The Fibonacci retracements pattern can be useful for swing traders to identify reversals on a stock chart. On this page we will look at the Fibonacci sequence and show some examples of how you can identify this pattern.

Fibonacci numbers were developed by Leonardo Fibonacci and it is simply a series of numbers that when you add the previous two numbers you come up with the next number in the sequence. Here is an example:

1, 2, 3, 5, 8, 13, 21, 34, 55

See how when you add 1 and 2 you get 3? Now add 2 and 3 and you get 5, and so on. So how does this sequence help you as a swing trader?

Well, the relationship between these numbers is what gives us the common Fibonacci retracements pattern in technical analysis.

Fibonacci retracements pattern

Stocks will often pull back or retrace a percentage of the previous move before reversing. These Fibonacci retracements often occur at three levels: 38.2%, 50%, and 61.8%. Actually, the 50% level really does not have anything to do with Fibonacci, but traders use this level because of the tendency of stocks to reverse after retracing half of the previous move. Here is an example using a graphic explaining the retracement pattern:

This picture shows a graphical representation of the reversal points for stocks in an uptrend. The pattern is reversed for stocks that are in down trends.

After a stock makes a move to the upside (A), it can then retrace a part of that move (B), before moving on again in the desired direction (C). These retracements or pullbacks are what you as a swing trader want to watch for when initiating long or short positions.

Once the stock begins to pull back (retrace), then you can plot these retracement levels on a chart to look for signs of a reversal. You do not automatically buy the stock just because it is at a common retracement level! Wait, and look for candlestick patterns to develop at the 38.2% area. If you do not see any signs of a reversal, then it may go down to the 50% area. Look for a reversal there. You do not know if or when the stock will reverse at a Fibonacci level! You just mark these areas on a chart and wait for signal to go long or short.

How to draw a fib grid

So how do we identify Fibonacci patterns on a chart. Easy, we draw a Fibonacci grid (fib grid) using swing points. Here is an example:

Draw the fib grid from the swing point high and the swing point low of a swing. Your charting software should come with this feature. It is a standard option on most charting packages. If not, you can calculate it manually by using this formula:

Calculate the range from the swing point high to the swing point low.

Now multiply the range times a Fibonacci ratio: 38.2% (0.382), 50% (0.500), and 61.8% (0.618).

Finally, subtract that number from the swing point high. That will give you your Fibonacci levels.

This chart shows an actual trade that I made. HS pulled back into the TAZ and then formed a bullish engulfing candle right at the 50% level. That gave me the signal to go long. Nice trade!

Is it useful?

Well...maybe...sometimes...

Most of the time, when you draw a fib grid on a chart, you will notice that the grid lines up with support and resistance areas that you would see anyway without drawing the lines in! So you really do notneed to draw the lines in. Instead, you can just look at a chart and estimate where the levels are.

Look again at the chart above of HS. If you didn't draw the Fibonacci retracement lines in, you can still tell just by looking at the chart that the stock has retraced 50% of the previous move.

If drawing the lines in helps you to better visualize the fib levels, then by all means use it! The choice is up to you.

Forex Risks

The trading of foreign exchange currencies involves risks. The evaluation of the grade or severity of risk should always be taken into account before executing a trade.

The following are the major risk factors in FX trading:

·         Exchange Rate Risk

·         Interest Rate Risk

·         Credit Risk

·         Country Risk

·         Liquidity Risk

·         Marginal or Leverage Risk

·         Transactional Risk

·         Risk of Ruin

Exchange Rate Risk

Exchange rate risk is the risk involved based on the effect of the continuous and usually volatile shift in the worldwide market supply and demand balance on an outstanding foreign exchange position. For the period the trader’s position is outstanding, the position is subject to all price changes. This risk can be quite substantial and is based on the market's perception of which way the currencies will move based on all possible factors that happen (or could happen) at any given time, anywhere in the world. Additionally, because the off-exchange trading of Forex is largely unregulated, no daily price limits are imposed as exist for regulated futures exchanges. The market moves based on fundamental and technical factors - more about this later.

The most popular methodology implemented in trading is cutting losses and riding profitable positions, in order to insure that losses are kept within manageable limits. This common sense methodology includes:

The Position Limit

A "position limitation" is establishing the maximum amount of any currency a trader is allowed to carry, at any single time.

The Loss Limit

The loss limit is a measure designed to avoid unsustainable losses made by traders by means of setting stop loss levels. It is imperative that you have stop loss orders in place.

Simple Risk / Reward Ratios

A simple method traders use as a guideline when trying to control exchange rate risk is to measure their intended gains against their possible losses. The idea is that most traders will lose twice as many times as they profit, so a simple guide to trading is to keep your risk/reward ratio to 1:3. This is illustrated in detail in a later section.

Interest Rate Risk

Interest rate risk refers to the profit and loss generated by fluctuations in the forward spreads, along with forward amount mismatches and maturity gaps among transactions in the foreign exchange book. This risk is pertinent to currency swaps; forward outright, futures, and options. To minimize interest rate risk, one sets limits on the total size of mismatches. A common approach is to separate the mismatches, based on their maturity dates, into up to six months and past six months. All the transactions are entered in computerized systems in order to calculate the positions for all the dates of the delivery, gains and losses. Continuous analysis of the interest rate environment is necessary to forecast any changes that may impact on the outstanding gaps.

Credit Risk

Credit risk refers to the possibility that an outstanding currency position may not be repaid as agreed, due to a voluntary or involuntary action by a counterparty. Credit risk is usually something that is a concern of corporations and banks. For the individual trader (trading on margin), credit risk is very low as this also holds true for companies registered in and regulated by the authorities in G-7 countries. In recent years, the National Futures Association (NFA) and the Commodity Futures Trading Commission (CFTC) have asserted their jurisdiction over the FX markets in the US and continue to crack down on unregistered FX firms. Countries in Western Europe follow the guidelines of the Financial Services Authority in the UK. This authority has the strictest rules of any country in making sure that FX companies under their jurisdiction are keeping qualified customer funds secure. It is important for all individual traders to thoroughly check out companies before sending any funds for trading. It is fairly easy to check out the companies you are considering by visiting the authorities' websites: The CFTC's website is http://www.cftc.gov/, the NFA website is http://www.nfa.futures.org/, and the FSA's website is http://www.fsa.gov.uk/. Most companies are happy to answer inquiries from customers and often post notices pertaining to security of funds on their website. It should be noted, however, that minimum capital requirements for Futures Commission Merchants ("FCMs") registered with the CFTC are much less than those of banks, and under present CFTC regulations and NFA rules, protections related to the segregation of customer funds for regulated futures accounts do not extend fully to funds deposited to collateralize off-exchange currency trading. For these and other reasons, the CFTC and NFA discourage any representation that the registration status of a Futures Commission Merchant substantially reduces the risks inherent in over-the-counter Forex trading.

The known forms of credit risk are:

Replacement Risk

Replacement risk occurs when counter-parties of a failed bank or Forex broker find they are at risk of not receiving their funds from the failed bank.

Settlement Risk

Settlement risk occurs because of the difference of time zones on different continents. Consequently, currencies may be traded at different prices at different times during the trading day. Australian and New Zealand Dollars are credited first, then the Japanese Yen, followed by the European currencies and ending with the US Dollar. Therefore, payment may be made to a party that will declare insolvency or be declared insolvent, prior to that party executing its own payments.

In assessing credit risk, the trader must consider not only the market value of their currency portfolios, but also the potential exposure of these portfolios.

The potential exposure may be determined through probability analysis over the time to maturity of the outstanding position. The computerized systems currently available are very useful in implementing credit risk policies. Credit lines are easily monitored. In addition, the matching systems introduced in foreign exchange since April 1993, are used by traders for credit policy implementation as well. Traders input the total line of credit for a specific counter-party. During the trading session, the line of credit is automatically adjusted. If the line is fully used, the system will prevent the trader from further dealing with that counter-party. After maturity, the credit line reverts to its original level.

Dictatorship Risk

Dictatorship (sovereign) risk refers to a government's interference in the Forex marketplace. Although theoretically present in all foreign exchange instruments - currency futures are, for all practical purposes, exempt from country risk, for the reason that the major currency futures markets are located in the US.

However, traders must account for all types of risk and take the necessary measures to account for possible administrative restrictions that may affect their market positions.

Counter-party Default Risk

Over-the-counter ("OTC") spot and forward contracts in currencies are not traded on exchanges; rather, banks and FCM's typically act as principals in this market. Because performance of spot and forward contracts on currencies is not guaranteed by any exchange or clearing house, the client is subject to counter-party risk -- the risk that the principals with a trader, the trader's bank or FCM, or the counter-parties with which the bank or FCM trades, will be unable or will refuse to perform with respect to such contracts. Furthermore, principals in the spot and forward markets have no obligation to continue to make markets in the spot and forward contracts traded.

In addition, the non-centralized nature of the Foreign Exchange market produces the following complications:

A bank or FCM may decline to execute an order in a currency market which it believes to present a higher than acceptable level of risk to its operations. Because there is no central clearing mechanism to guarantee OTC trades, each bank or FCM must apply its own risk analysis in deciding whether to participate in a particular market where its credit must stand behind each trade. Depending on the policies adopted by each counter-party, a given bank or FCM may decline to execute an order placed by a trader/customer. This has happened on occasion in the past, and will no doubt happen again, in response to volatile market conditions.

Because there is no central marketplace disseminating minute-by-minute time and sales reports, banks and FCMs must rely on their own knowledge of prevailing market prices in agreeing to an execution price. The execution price obtained for a trader/customer to a large extent will reflect the expertise of the bank or FCM in trading the particular currency. While the OTC interbank market as a whole is highly liquid, certain currencies, known as exotics, are less frequently traded by any but the largest dealers. For this reason, a less experienced counter-party may take longer to fill an order or may obtain an execution price that differs widely from what a more experienced or larger counter-party will obtain. As a consequence, two participants trading in the same markets through different counter-parties may achieve markedly different rates of return during times of high market volatility.

The financial failure of counter-parties could result in substantial losses. Again, when trading Foreign Currencies on an OTC basis, the trader/customer will be dealing with institutions as principals and institutions may be subject to losses or insolvency. In case of any such bankruptcy or loss, the trader might recover, even in respect of property specifically traceable to his or her account, only a pro rata share of all property available for distribution to all of the counter-party's customers.

While that portion of a trader/customer's assets deposited with an FCM with respect to regulated exchange traded futures will be subject to the limited regulatory protections afforded by the client segregation rules and procedures, customer funds deposited to secure or margin OTC Foreign Exchange trading will not have such protection, as FCM's are exempt from substantial regulation under the Commodity Exchange Act for their activities as counter-party to non-exchange traded currency contracts.

Country and Liquidity Risk

Although the liquidity of OTC Forex is in general much greater than that of exchange traded currency futures, periods of illiquidity nonetheless have been seen, especially outside of US and European trading hours. Additionally, several nations or groups of nations have in the past imposed trading limits or restrictions on the amount by which the price of certain Foreign Exchange rates may vary during a given time period, the volume which may be traded, or have imposed restrictions or penalties for carrying positions in certain foreign currencies over time. Such limits may prevent trades from being executed during a given trading period. Such restrictions or limits could prevent a trader from promptly liquidating unfavorable positions and, therefore could subject the trader's account to substantial losses. In addition, even in cases where Foreign Exchange prices have not become subject to governmental restrictions, the General Partner may be unable to execute trades at favorable prices if the liquidity of the market is not adequate. It is also possible for a nation or group of nations to restrict the transfer of currencies across national borders, suspend or restrict the exchange or trading of a particular currency, issue entirely new currencies to supplant old ones, order immediate settlement of a particular currency obligations, or order that trading in a particular currency be conducted for liquidation only. OTC Forex is traded on a number of non-US markets, which may be substantially more prone to periods of illiquidity than the United States markets due to a variety of factors.

Additionally, even where stop loss or limit orders are put in place to attempt to limit losses, these orders may not be executable in very illiquid markets, or may be filled at unforeseeably unfavorable price levels where illiquidity or extreme volatility prevent their more favorable execution.

Leverage Risk

Low margin deposits or trade collateral are normally required in Foreign Exchange, (just as with regulated commodity futures). These margin policies permit a high degree of leverage. Accordingly, a relatively small price movement in a contract may result in immediate and substantial losses in excess of the amount invested. For example, if at the time of purchase, 10% of the price of a contract were deposited as margin, a 10% decrease in the price of the contract would, if the contract were then closed out, result in a total loss of the margin deposit before any deduction for brokerage commissions. A decrease of more than 10% would result in a total loss of the margin deposit. Some traders may decide to commit up to 100% of their account assets for margin or collateral for Foreign Exchange trading. Traders should be aware that the aggressive use of leverage will increase losses during periods of unfavorable performance.

Transactional Risk

Errors in the communication, handling and confirmation of a trader's orders (sometimes referred to as "out trades") may result in unforeseen losses. Often, even where an out trade is substantially the fault of the dealing counter-party institution, the trader/customer's recourse may be limited in seeking compensation for resulting losses in the account.

Risk of Ruin

Even where a trader/customer's medium to longer term view of the market may be ultimately correct, the trader may not be able to financially bear short-term unrealized losses, and may close out a position at a loss simply because he or she is unable to meet a margin call or otherwise sustain such positions. Thus, even where a trader's view of the market is correct, and a currency position may ultimately turn around and become profitable had it been held, traders with insufficient capital may experience losses.

How to Read a Candle Chart

What could possibly be more important to a technical Forex trader than their price charts? Your perception of price will ultimately help shape your opinions of trends, determine entries, and more. With this in mind it becomes absolutely critical to understand what you are seeing on your trading monitor. More often than not Forex charts are defaulted with candlestick charts which differ greatly from the more traditional bar chart and the more exotic renko charts that you may come across in your trading career. Surprisingly after learning to analyze candlesticks, traders often find they are able to quickly identify different types of price action that they could not quickly identify before with othertypes of charts.

To begin with, traders need to understand exactly how to read candlesticks before adding them into an existingtrading strategy. So let’s get started learning about how to read a candlestick chart!

How to Read Candles

The image below represents the design of a typical candlestick. There are three specific points (open, close, wicks) that are used in the creation of a price candle. The first points we need to consider are the candles open and close prices. These points identify where price began and concluded for a selected period and will construct the body of a candle. If you are viewing a daily chart for instance, these points will represent the daily open and close price. It is important to note the color of the body of a candlestick (red for down and blue for up). Knowing this, candlesticks can help us quickly identify if the market is trading higher or lower for a selectedtime frame.

Next we have the wicks of our candlesticks, which may also be referred to as the candles shadow. These points are vital as they show the extremes in price for a specific charting period. The wicks are quickly identifiable as they are visually thinner than the body of the candlestick. This is where the strength of candlesticks becomes apparent. Candlesticks can help us keep our eye on market momentum and away from the static of price extremes.

Uses in Trading

As you can now see, candlesticks are easy to read with a little bit of practice. Once you understand the basics, they have the ability to open up an array of trading opportunities. While a trader may not employ candlestick analysis alone in their strategies, Forex professionals do use them to gauge market sentiment and market direction. Now that you are familiarized with the basics your next step is to continue learning by reviewing candle patterns, such as the bullish engulfing pattern, which can be used in conjuncture with a strong trending market.

Inflation: Conclusion

After reading this tutorial, you should have some insight into inflation and its effects. For starters, you now know that inflation isn't intrinsically good or bad. Like so many things in life, the impact of inflation depends on your personal situation.

Some points to remember:

• Inflation is a sustained increase in the general level of prices for goods and services.
• When inflation goes up, there is a decline in the purchasing power of money.
• Variations on inflation include deflation, hyperinflation and stagflation.
• Two theories as to the cause of inflation are demand-pull inflation and cost-push inflation.
• When there is unanticipated inflation, creditors lose, people on a fixed-income lose, "menu costs" go up, uncertainty reduces spending and exporters aren't as competitive.
• Lack of inflation (or deflation) is not necessarily a good thing.
• Inflation is measured with a price index.
• The two main groups of price indexes that measure inflation are the Consumer Price Index and the Producer Price Indexes.
• Interest rates are decided in the U.S. by the Federal Reserve. Inflation plays a large role in the Fed's decisions regarding interest rates.
• In the long term, stocks are good protection against inflation.
• Inflation is a serious problem for fixed income investors. It's important to understand the difference between nominal interest rates and real interest rates.
• Inflation-indexed securities offer protection against inflation but offer low returns.

Inflation And Investments

When it comes to inflation, the question on many investors' minds is: "How will it affect my investments?" This is an especially important issue for people living on a fixed income, such as retirees.

The impact of inflation on your portfolio depends on the type of securities you hold. If you invest only in stocks, worrying about inflation shouldn't keep you up at night. Over the long run, a company's revenue and earnings should increase at the same pace as inflation. The exception to this is stagflation. The combination of a bad economy with an increase in costs is bad for stocks. Also, a company is in the same situation as a normal consumer - the more cash it carries, the more its purchasing power decreases with increases in inflation.

The main problem with stocks and inflation is that a company's returns tend to be overstated. In times of high inflation, a company may look like it's prospering, when really inflation is the reason behind the growth. When analyzing financial statements, it's also important to remember that inflation can wreak havoc on earnings depending on what technique the company is using to value inventory.

Fixed-income investors are the hardest hit by inflation. Suppose that a year ago you invested $1,000 in a Treasury bill with a 10% yield. Now that you are about to collect the $1,100 owed to you, is your $100 (10%) return real? Of course not! Assuming inflation was positive for the year, your purchasing power has fallen and, therefore, so has your real return. We have to take into account the chunk inflation has taken out of your return. If inflation was 4%, then your return is really 6%

This example highlights the difference between nominal interest rates and real interest rates. The nominal interest rate is the growth rate of your money, while the real interest rate is the growth of your purchasing power. In other words, the real rate of interest is the nominal rate reduced by the rate of inflation. In our example, the nominal rate is 10% and the real rate is 6% (10% - 4% = 6%).

As an investor, you must look at your real rate of return. Unfortunately, investors often look only at the nominal return and forget about their purchasing power altogether.

Inflation-Indexed Bonds
There are securities that offer investors the guarantee that returns will not be eaten up by inflation. Treasury inflation-protected securities (TIPS), are a special type of Treasury note or bond. TIPS are like any other Treasury, except that the principal and coupon payments are tied to the CPI and increase to compensate for any inflation.

This may sound like a good thing, but the running joke on Wall Street is that it's easier to sell an air conditioner in the dead of winter than it is to convince investors they need protection from inflation. Inflation has been so low in recent years that it hasn't been much of an issue. Because these securities are so safe, they offer an extremely low rate of return. For most investors, inflation-indexed securities simply don't make sense.

Inflation And Interest Rates

Whenever you hear the latest inflation update on the news, chances are that interest rates are mentioned in the same breath.

In the United States, interest rates are decided by the Federal Reserve. The Fed meets eight times a year to set short-term interest rate targets. During these meetings, the CPI and PPIs are significant factors in the Fed's decision.

Interest rates directly affect the credit market (loans) because higher interest rates make borrowing more costly. By changing interest rates, the Fed tries to achieve maximum employment, stable prices and a good level growth. As interest rates drop, consumer spending increases, and this in turn stimulates economic growth. (To learn how trade currencies using these economic reports, read Forex Walkthrough: The Fed.)

Contrary to popular belief, excessive economic growth can in fact be very detrimental. At one extreme, an economy that is growing too fast can experience hyperinflation, resulting in the problems we mentioned earlier. At the other extreme, an economy with no inflation has essentially stagnated. The right level of economic growth, and thus inflation, is somewhere in the middle. It's the Fed's job to maintain that delicate balance. A tightening, or rate increase, attempts to head off future inflation. An easing, or rate decrease, aims to spur on economic growth.

Keep in mind that while inflation is a major issue, it is not the only factor informing the Fed's decisions on interest rates. For example, the Fed might ease interest rates during a financial crisis to provide liquidity (flexibility to get out of investments) to U.S. financial markets, thus preventing a market meltdown.

Inflation: How Is It Measured?

Measuring inflation is a difficult problem for government statisticians. To do this, a number of goods that are representative of the economy are put together into what is referred to as a "market basket." The cost of this basket is then compared over time. This results in a price index, which is the cost of the market basket today as a percentage of the cost of that identical basket in the starting year.

In North America, there are two main price indexes that measure inflation:

• Consumer Price Index (CPI) - A measure of price changes in consumer goods and services such as gasoline, food, clothing and automobiles. The CPI measures price change from the perspective of the purchaser. U.S. CPI data can be found at the Bureau of Labor Statistics.
• Producer Price Indexes (PPI) - A family of indexes that measure the average change over time in selling prices by domestic producers of goods and services. PPIs measure price change from the perspective of the seller. U.S. PPI data can be found at the Bureau of Labor Statistics. 

You can think of price indexes as large surveys. Each month, the U.S. Bureau of Labor Statistics contacts thousands of retail stores, service establishments, rental units and doctors' offices to obtain price information on thousands of items used to track and measure price changes in the CPI. They record the prices of about 80,000 items each month, which represent a scientifically selected sample of the prices paid by consumers for the goods and services purchased. 

In the long run, the various PPIs and the CPI show a similar rate of inflation. This is not the case in the short run, as PPIs often increase before the CPI. In general, investors follow the CPI more than the PPIs.

What Is Inflation?

Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every dollar you own buys a smaller percentage of a good or service.

The value of a dollar does not stay constant when there is inflation. The value of a dollar is observed in terms of purchasing power, which is the real, tangible goods that money can buy. When inflation goes up, there is a decline in the purchasing power of money. For example, if the inflation rate is 2% annually, then theoretically a $1 pack of gum will cost $1.02 in a year. After inflation, your dollar can't buy the same goods it could beforehand.

There are several variations on inflation:

• Deflation is when the general level of prices is falling. This is the opposite of inflation.
• Hyperinflation is unusually rapid inflation. In extreme cases, this can lead to the breakdown of a nation's monetary system. One of the most notable examples of hyperinflation occurred in Germany in 1923, when prices rose 2,500% in one month!
• Stagflation is the combination of high unemployment and economic stagnation with inflation. This happened in industrialized countries during the 1970s, when a bad economy was combined with OPEC raising oil prices.

In recent years, most developed countries have attempted to sustain an inflation rate of 2-3%. 

Causes of Inflation 
Economists wake up in the morning hoping for a chance to debate the causes of inflation. There is no one cause that's universally agreed upon, but at least two theories are generally accepted: 

Demand-Pull Inflation - This theory can be summarized as "too much money chasing too few goods". In other words, if demand is growing faster than supply, prices will increase. This usually occurs in growing economies.

Cost-Push Inflation - When companies' costs go up, they need to increase prices to maintain their profit margins. Increased costs can include things such as wages, taxes, or increased costs of imports.

Costs of Inflation
Almost everyone thinks inflation is evil, but it isn't necessarily so. Inflation affects different people in different ways. It also depends on whether inflation is anticipated or unanticipated. If the inflation rate corresponds to what the majority of people are expecting (anticipated inflation), then we can compensate and the cost isn't high. For example, banks can vary their interest rates and workers can negotiate contracts that include automatic wage hikes as the price level goes up.

Problems arise when there is unanticipated inflation: 

• Creditors lose and debtors gain if the lender does not anticipate inflation correctly. For those who borrow, this is similar to getting an interest-free loan.
• Uncertainty about what will happen next makes corporations and consumers less likely to spend. This hurts economic output in the long run.
• People living off a fixed-income, such as retirees, see a decline in their purchasing power and, consequently, their standard of living.
• The entire economy must absorb repricing costs ("menu costs") as price lists, labels, menus and more have to be updated.
• If the inflation rate is greater than that of other countries, domestic products become less competitive.

People like to complain about prices going up, but they often ignore the fact that wages should be rising as well. The question shouldn't be whether inflation is rising, but whether it's rising at a quicker pace than your wages.

Finally, inflation is a sign that an economy is growing. In some situations, little inflation (or even deflation) can be just as bad as high inflation. The lack of inflation may be an indication that the economy is weakening. As you can see, it's not so easy to label inflation as either good or bad - it depends on the overall economy as well as your personal situation.