Forex Fundamentals

Learn how key market drivers and economic indicators can impact currency prices.

What are Economic Indicators?

Economic indicators are snippets 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 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 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 when making trading decisions based on this data.

Mark Your 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.

Know exactly when each economic indicator will be released. You can find these calendars at the New York Federal Reserve Bank's site; TradeKing Forex clients can access the Economic Calendar through the TradeKing ForexTrader Desktop platform.

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 may pay attention to different indicators under different conditions. That focus can change over time and from one currency to another. 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.

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 to focus on the numbers that can inform their trading decisions.

For example, many new traders watch the headlines 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 payroll 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 a surprising impact on your currency market. Doing your homework before trading any currency can help you make better decisions.

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. 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 Leading Economic Indicators Include

  • 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.

  • 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.

  • 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.

  • 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.

Major Lagging Economic Indicators Include

  • 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.

  • 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.

  • 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.