Don’t let yourself be misled by the use of the word “indicator”: market economy indicators are not the same analytical indicators utilized by traders, such as stochastics or moving averages, to plan their market entry and exit points and confirm their hunches, but rather, market economy indicators are bits of economic data and information released by governments and private sector interest groups which summarize various aspects and facets of a nation’s economy and as such, serve as a reflection of the given country’s economic health, wealth and prospects. The release of these indicators has a significant impact on the forex markets both in terms of substance as well as in terms of timing and in fact, play a major role not only in forex pricing but in forex forecasting, forward trading and the pricing of forward forex options as well.
While we continue to stress that on-going education is a critical component of any retail forex trader’s trading success, we must also emphasize that staying abreast of economic indicators directly affecting forex prices is a crucial component of any forex trader’s on-going education. In the United States, many of these salient indicators are released to the public on a regular basis, according to a calendar which is easily accessible online, whether from the Federal Reserve’s own website or even from the many forex brokers who provide the calendar on their own websites as a service to their retail clientele. We cannot stress with sufficient emphasis how important it is that a forex trader not only becomes familiar with the type and nature of such regularly released information, but with their certain effect on forex prices as well: the trader who understands how to interpret economic market indicators has a distinct advantage over those who do not, because he is in a position to trade in front of, instead of behind, the trend.
Market indicators can generally be placed into the two categories of “leading” or “lagging” indicators. Leading indicators, used to predict likely changes in the economy, are economic factors that change before the change in the economy (or in the forex markets) has happened; such changes then result from the announcement of the leading indicators. They include forecasts of stock prices, of unemployment, of inflation and the like, and are utilized by commercial banks and economic institutions to predict interest rates and thus, market trends; in the context of forex trading, then, a leading indicator will signal to the forex trader that a trend is about to begin, allowing for the achieving of maximum profits provided that the trader knows how to interpret the leading indicators correctly.
Lagging market indicators highlight changes that have already occurred within an economy and as such, tend to report on trends after the fact. Examples of lagging indicators can include housing starts, actual unemployment figures, the consumer price index and similar relevant bits of economic data. As in real life, since hindsight is always 20/20, lagging indicators of every variety are abundant, encompassing everything from changes in inflation rates to changes in forex prices, gross domestic product or even retail sales, over the reported time period. In general, lagging indicators do not precipitate trends, but rather follow them. As such, they are helpful to the trader in that their interpretation can assist him in tweaking his strategy for the upcoming trading period.
Leading or lagging, some indicators have a greater impact on the forex market and on currency prices than do others, and a currency trader conversant with these indicators and knowledgeable about their general impact on the economy, such as a change in inflation or a change in prevailing interest rates, can optimize his trading profits by incorporating these statistics into his trades either just before, or just after, the corresponding announcements are made. It’s also interesting to note that very often, it is not the announcement itself that moves changes in the market but simply the anticipation of the announcement, as pundits and experts make their predictions regarding what the to-be released indicators might reveal, and the markets react in kind. These forecasts can also be easily researched and accessed online, and savvy traders will arm themselves on a regular basis with the most significant of these opinions, since they realize the importance of this anticipation. An example of this behavior would be a trader going short in a particular currency in the face of rumblings regarding higher producer price index figures (generally accepted to be a harbinger of inflation, which itself can be understood as the cost of a nation’s domestic currency).
In the United States, the indicators which tend to have the greatest residual impact on the price of a dollar in the foreign currency markets are gross domestic product (GDP), which measures the total output of the US economy in a given time period; the producer price index (PPI), which measures the cost of manufacturing; the consumer price index (CPI), which measures the cost of goods and services typically purchased by US consumers; retail sales figures, which reflect consumer spending and thus consumer confidence in the domestic economy; and housing starts, which measures new residential home construction and provides a different reflection of consumer confidence in the US economy. Taken as a whole, these indicators provide a rather complete picture of the health of the economy: as an example, consider that if housing starts and retail sales are up, then interest rates are likely low and further, are likely to remain low; consumers will feel confident enough to invest in both a home and the durable goods needed to furnish them. Seeking low interest rates, capital will naturally be attracted to the country, increasing demand for the country’s currency and causing it to appreciate, or strengthen, against other floating rate currencies. In the face of such figures a trader would be wise to go long in the strong domestic currency, adjusting his stops as he sticks with the upward trend for as long as is viable.
It’s important to remember that currencies are traded in pairs and that it is necessary to follow the appropriate indicators in both countries whose currencies you trade. Without knowing both sides of the story, you cannot be fully prepared to take advantage of a rally or to mitigate your risk in the case of a downswing. It may appear to be an enormous amount of external economic data to digest, but it won’t take long until the trader realizes that the announcement of economic indicators follows a regular schedule, making it easy to fall into the rhythm of following these pertinent statistics as they are released. If you’re interested in trading in the forex markets but are not following these indicators of market economy on a regular basis, then you’re not trading in as efficient a manner as you could—or should—be. If there ever were an example of a situation where the investment of time pays off in terms of increased financial gain, this is it, so know your indicators inside and out, and pay close attention to what they’re telling you.