A standard exchange rate shows the ratio with a single currency in nominal terms. The real effective exchange rate accounts for two additional factors: a basket of currencies from major trading partners weighted by trade volumes, and the difference in price growth rates.
Inflation adjustment is fundamental. If the national currency weakened by 10%, but domestic prices rose 15% faster than in partner countries, then in real terms it strengthened — domestically produced goods became more expensive relative to imports, despite nominal depreciation.
This is why the indicator is used to assess export competitiveness. Real appreciation worsens exporters' positions and makes imports more attractive, regardless of how the nominal rate appears.
For private investors, this is a background indicator. It cannot predict exchange rates, but explains why sustained nominal stability can mask mounting pressure: divergence between real and nominal rates signals accumulating imbalances.