Economic Indicators in Forex Trading Pt. 1
We already talked about the basic concepts of fundamental analysis and the connection between a nation’s economic trends and the value of its currency. In our current post, we will delve deeper into the individual economic indicators that help traders understand the underlying processes of the economy and the direction that the economy is headed.
In today’s financial markets every little news release is quickly integrated into sophisticated models and systematic trading algorithms all over the globe, so one could think that it’s hard to make money through simple analysis. While this has some truth to it, the reality is much more complex and models often miss the “big picture” that a human mind can quickly comprehend. An indicator can be crucial in one moment and totally irrelevant in another. A trader can easily outperform systematic trading “robots” on particular time-frames, if he/she understands the relevance of a certain data point in a certain time.
The different types of economic indicators
Grouping economic indicators can be done in several ways; we will use two different methods to make your trading easier. First, we will set up groups according to the part of the economy that the indicator deals with. Adding another dimension to the analysis, we will also determine the general importance of the given indicator on a scale of three. As we already stated this isn’t set in stone—the significance of an indicator may differ from country to country and from time to time as well.
Also, always remember that every report and indicator needs to be understood in the context of the given situation and the connections that the indicator has to other parts of the economy, such as the monetary conditions. Sometimes a seemingly good economic report might lead to a negative reaction by the currency because of the expected change in the country’s monetary policy.
It might be obvious, but a currency pair consists of two currencies (and probably even more countries are affected, as in the case of the Euro), so keeping track of the economic indicators of only one country is never enough to determine the expected course of a currency cross. This is especially true in the case of smaller or exotic currencies, as the economic and monetary developments of the “majors” always have a profound effect on the less important currencies as well.
A perfect example has been the recent rate hike by the Federal Reserve and the subsequent strong devaluation of dozens of “minor” currencies, and even some of the majors. This means that following the economic numbers of the three most important currencies (the U.S. Dollar, the Euro, and the Japanese Yen) is strongly recommended. In recent years, and especially in the case of the “connected” currencies, the Chinese Yuan joined the ranks of the top 3 currencies in terms of significance, as the weight of the Chinese economy skyrocketed.
With all that in mind, here are the primary categories of the most important economic indicators :
- Labor market
- Retail Data
- Industrial Production and services
- Housing and credit data
- Monetary measures and Inflation Data
- Trade Data
- Growth (GDP) data
- Special releases (commodity inventories and prices, leading indicators etc.)
Labor market indicators
- Unemployment rate (importance: 2)
- Payrolls (importance:3)
- Unemployment Claims (importance: 2)
- Average earnings (importance: 2)
The labor market of a country is probably the most important indicator of economic activity, as the GDP of a nation, and in turn, the demand for a currency is primarily generated by the employees. Of course, this is a bit of simplistic view, but nevertheless, the labor market is a vital part of the big picture. The raw number of employment is usually more closely watched by the professionals than the more popular unemployment rate, because the latter is highly dependent on the method of its calculation, often giving false signals about the economic trends.
The trend in average earnings is also crucial, especially in inflationary periods; the change in wages is a very important indicator of the underlying inflationary pressures.
- Retail sales (importance: 3)
- Consumer Confidence (importance: 2)
- Consumer Credit (importance: 1)
- Same store sales (importance: 1)
- Vehicle sales (importance: 2)
In today’s economies, the consumer is responsible for the 50-75% of the economic activity making retail data and related releases a great indicator of future economic activity as well as the current trends. Producers react to changes of consumer demand quickly, that usually translates to changes in production with a slight lag.
Industrial production and services
- Manufacturing PMI (importance: 2)
- Non-manufacturing PMI (importance: 2)
- Industrial production (importance: 1)
- Durable goods orders (importance: 2)
Industrial production in itself is not the best predictor of economic activity as it usually lags behind other indicators, with many stages of activity being ahead in the production cycle. That, said PMIs or Purchasing Manager Indices offer an early indication of significant changes. On a negative note, these indices are very volatile in nature and even one unusual event might cause a sudden and often transitory change in them.
The primary rules of economic trends, therefore, are even truer regarding these indicators—always look at the trends rather than focusing on individual data points! Durable Goods Orders are useful and often overlooked by traders, despite the relatively strong correlation with future production.
We hope you enjoyed the first part of this article on Economic Indicators. Stay tuned for for the second part of this article and more interesting and useful forex resources to guide you on your forex Journey!