Economic Indicators (Forex Education)

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By Roger Baettig | August 31, 2010 11:28 PM EST

Economic indicators are snippets of financial and economic data published regularly by governmental agencies and the private sector.

An economic indicator is information amassed and published by a government or private entity recording the activity in a particular economic sector, either in a specific industry or in an entire economy. Most indicators are statistical, but they can be anecdotal or subjective as well. Indicators are recorded and published on a regular basis by many organizations and are used by traders to assess the strengths or weaknesses of an economy, to predict future activity, to judge central bank policy, and to provide insight into the many economic variables that make up a modern industrial economy.

Most indicators are classified as leading or lagging. Leading indicators are those that track economic factors that usually change before the general economy and are used to predict future economic conditions. Lagging indicators record activity that has already taken place, and may or may not be useful in prediction.

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 traders need only keep a few simple guidelines in mind to making trading decisions based on this data.

Economy-wide indicators are the broadest measures of productive activity and record the result for an entire economy. Usually collected by governments, they are among the most authoritative statistics.

Examples are:

- Gross Domestic Product (GDP)
- Consumer Price Index (CPI)
- Producer Price Index (PPI)
- Unemployment Rate

Industry and sector based statistics normally pertain to a particular industry, such as housing or a particular economic activity, such as retail sales. Collected by both government agencies and private sector groups, the activity they track is more limited, and can have a close correlation to the broader indices, generating considerable trading interest.

Examples are:

- Durable Goods Orders
- Housing Starts
- Building Permits
- New Home Sales
- Retail Sales
- Purchasing Managers Index
- Institute for Supply Management (ISM) Survey

The final group is sentiment indicators, which gauge business and consumer opinions on current economic conditions and their expectations and intentions for the future.

Not all statistics on a single topic are of equal importance. Some government and central banks prefer one measure to another and the markets will assign that much more trading weight to the favored statistic. Other statistics gain or lose interest over time depending on their volatility, changes in the economy or newer and better measurement techniques.

Traders will also focus on different statistics depending on what is felt to be more pertinent to current economic and market conditions. If market focus is on GDP growth then economy-wide statistics will be paramount. If developments in a particular industry are of concern then those statistics will be uppermost in traders' minds.

Mark your economic calendars

Know exactly when each economic indicator will be released. You can find these calendars at the New York Federal Reserve Bank's site; Forex Broker clients can simply login to MyAccount and click on Economic Calendars.

Watching the economic calendar not only helps you consider trades around these events, it helps explain otherwise unanticipated price actions during those periods. Consider this scenario: it's Monday morning and the USD has been in a tailspin for 3 weeks, with many traders short USD positions as a result. On 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.

What does this data mean for the economy?

You need not understand every nuance of each data release, but you should try to grasp 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 indicators can move markets

The market often pays more attention to certain indicators under certain conditions - and that focus can change over time. For example, if prices (inflation) are not a crucial issue for a given country, but its economic growth is problematic, traders may pay less attention to inflation data and focus on employment data or GDP reports.

Watch for the unexpected

Often the data itself may not be as important as whether or not it falls within market expectations. If a given report differs widely and unexpectedly from what economists and market pundits were anticipating, market volatility and potential trading opportunities may result.

At the same time, be careful of pulling the trigger too quickly when an indicator falls outside expectations. Each new economic indicator release contains revisions to previously released data. Here's an example:

Don't get caught up in details

While your macroeconomics professor may appreciate all the nuances of an economic report, traders need to filter data judiciously for their own purposes: making intelligent trading decisions.

For example, many new traders watch the headline New line of the employment report, for example, assuming that new jobs are key to economic growth. That may be true generally, 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 PPI excluding food and energy as a market driver. Food and energy data tend to be much too volatile and subject to revisions to provide an accurate reading on producer price changes.

There are two sides to every trade

Hopefully this has helped you realize the importance of watching economic indicators - and knowing which data are most likely to move markets and impact currency traders.

Just remember that no trader's knowledge can be complete all the time. You might have a great handle on economic data published in the U.S. - but there are times when data published in Europe or Australia might have surprising impact on your currency market. Doing your homework before trading any currency will help you stay on guard.

Economic indicators: a currency's vital signs

Traders can measure the economic health of a given country (and its currency) through its economic indicators - but, just like a doctor monitoring a patient's vital signs, not all stats count equally.

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 PPI is 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.

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