Economic indicators
Economic indicators are pieces of financial and economic data published regularly by governmental agencies and the private sector. These statistics help market observers monitor the economy’s pulse – so it’s no surprise that they’re religiously followed by almost everyone in the financial markets.
With so many people poised to react to the same information, economic indicators have tremendous potential to generate volume and to move prices. It might seem like you need an advanced economics degree to parse all this data accurately – but in fact people trading the Forex need only keep a few simple guidelines in mind to making trading decisions based on this data.
Know when the data is going to be released
Knowing when each piece of information will be released is important to successful trading. You can find these calendars on the Finexo.com web site.
Watching the economic calendar not only helps you decide how to trade using these events, it can help explain unanticipated price actions during those periods. For example: it’s the first Monday of a given month and the Dollar (USD) has been falling for close to two weeks, with many currency traders short USD positions as a result (meaning they sold the dollar and bought another currency). Friday, however, U.S. employment data is scheduled to be released. If that report looks promising, traders may start unwinding their short positions before Friday, leading to a short-term rally in USD through the week.
The reports and their effect on the overall economy
It is not important to understand every nuance of each data release, but it is vital to try and grasp the key, large-scale relationships between reports and what they measure in the economy. For example, you should know which indicators measure the economy’s growth (gross domestic product, or GDP) versus those that measure inflation (PPI, CPI) or employment strength (non-farm payrolls).
Not all economic data moves currency markets
The market usually pays more attention to some data, virtually ignoring others – it is important to know which ones can “move the market” and which ones are benign. The thing is, the focus given to a specific piece of information can change as the situation in that specific country changes. For example, if consumer prices, a.k.a. inflation are not a crucial issue for Japan, but its economic growth is problematic, currency traders might pay less attention to inflation data like the CPI (consumer price index) and focus on employment data or GDP reports.
Expectations and perceptions are everything
Many times, the data itself may not be as important as whether or not it is within the expectations set forth by the analyst, experts and pundits. If a specific report differs widely and unexpectedly from what economists and market gurus were expecting, market volatility and potential trading opportunities may result.
As well, be mindful to not act in haste when a piece of data does not come in with the expected range. Every piece of data that is released usually has adjustments to prior data. For example, the US PPI (producer price index) came in for November, it was lower than expected – however the dollar only got stronger, why? Along with the November data was an adjustment to the October data that showed a stronger PPI for that month. It is hard to factor these changes into a trade, however these changes usually only affect a currency after it is released – it is difficult to predict adjustments to prior data. Also, it is rare for a data adjustment to actually be so far off from the original data that it affects the position greatly. Traders rely on recent data, most of the time yesterdays news is kept in the past if the current situation shows something different.
How to use the data
While an economist on television might appreciate the small nuances of a report, stretching a small piece of information into a ten minute sketch, traders need to sift through the data for their own purposes allowing them to make intelligent trading decisions.
For example, many new traders watch business news networks when the Employment Report is released. They assume that new jobs are key to economic growth. That might be true, most of the time, but in trading terms non-farm payrolls is the figure traders watch most closely and therefore has the biggest impact on markets.
Similarly, PPI measures changes in producer prices generally – but traders tend to watch the PPI excluding food and energy as a market driver. Food and energy data tend to be much too volatile and subject to the revisions we spoke about earlier to provide an accurate reading on producer price changes.
The world is a very small place – the trickle down effect
Keeping up to date on the economies of the world is vital to trading currencies. Knowing not only what is happening in the countries of the currency you are not trading is as important as knowing what is happening in the countries that you trading.
It is important to understand that it is not just the data of a specific country that can affect that countries currency. The world is linked together very tightly, and the data from one country can have significant affects on others. As an example, the US exports most of the cotton that is grown there (the US is the largest cotton grower) to countries like China, whose economy is based on manufacturing. Sensing a slowdown in the recent world economy, China has cut production on clothing and textiles. This means that less cotton will be purchased by the Chinese over the next year, causing the price of Cotton to drop (supply and demand economics), in turn causing farmers in the US to make less money – in turn causing them to lay off workers – causing the unemployment level to grow. This action also brings down sales as the more unemployed eventually leads to a reduction in consumer spending.
Knowledge is everything – to successfully trade the Forex the key is to stay informed and remember the world is a very small place where the economic decision of one country can have a damaging affect on another.
What are the Key Indicators?
Traders can gauge the financial health of a given country (and its currency) through its economic data. But, just like a doctor monitoring a patient’s vital signs, the information is not equal in terms of its impact. Here’s a primer of the key economic indicators that often impact currency traders.
Economic indicators divide into leading and lagging indicators:
Leading indicators are economic factors that change before the economy starts to follow a particular trend. They’re used to predict changes in the economy.
Lagging indicators are economic factors that change after the economy has already begun to follow a particular trend. They’re used to confirm changes in the economy.
Major economic indicators
Gross Domestic Product (GDP)
The sum of all goods and services produced either by domestic or foreign companies. GDP indicates the pace at which a country’s economy is growing (or shrinking) and is considered the broadest indicator of economic output and growth.
Industrial Production
A chain-weighted measure of the change in the production of the nation’s factories, mines and utilities, industrial production also measures the country’s industrial capacity and how fully it’s being used (capacity utilization).
The manufacturing sector accounts for one-quarter of the major currencies’ economies, so it’s critical to watch the health of factories and whether their capacity is being maximized.
Purchasing Managers Index (PMI)
The National Association of Purchasing Managers (NAPM), now called the Institute for Supply Management, releases a monthly composite index of national manufacturing conditions. The index includes data on new orders, production, supplier delivery times, backlogs, inventories, prices, employment, export and import orders. It is divided into manufacturing and non-manufacturing sub-indices.
Producer Price Index (PPI)
Measures average changes in selling prices received by domestic producers in the manufacturing, mining, agriculture, and electric utility industries.
The PPIs most often used for economic analysis are those for finished goods, intermediate goods, and crude goods.
Consumer Price Index (CPI)
Measures the average price level paid by urban consumers (80% of the population in major currency countries) for a fixed basket of goods and services. It reports price changes in over 200 categories.
The CPI also includes various user fees and taxes directly associated with the prices of specific goods and services.
Durable Goods
Durable Goods Orders measures new orders placed with domestic manufacturers for immediate and future delivery of factory hard goods. A durable good is a product that lasts over three years, during which its services are extended.
Companies and consumers sometimes put off purchases of durable goods during tough economic times – so this figure is a useful measure of certain kinds of customer demand.
Employment Cost Index (ECI)
Payroll employment is a measure of the number of jobs at larger companies in more than 500 industries in all 50 U.S. states and 255 metropolitan areas. ECI counts the number of paid employees working part-time or full-time in the nation’s business and government establishments.
Retail Sales
Measures total receipts of retail stores from samples representing all sizes and kinds of business in retail trade throughout the nation. It is the timeliest indicator of broad consumer spending patterns and is adjusted for normal seasonal variation, holidays, and trading-day differences.
Retail sales include durable and nondurable merchandise sold, and services and excise taxes incidental to the sale of merchandise. It doesn’t include sales taxes collected directly from the customer.
Housing Starts
Measures the number of residential units on which construction is begun each month. A “start” refers to excavation of the foundation of a residential home.
Housing is usually one of the first sectors to react to interest rate changes. Significant reaction of start/permits to changing interest rates signals interest rates are nearing trough or peak. To analyze, focus on the percentage change in levels from the previous month. Report is released around the middle of the following month.
