Since the foreign exchange market has economic principles as its guiding light, it is only fitting that we apply them during trading decisions as well. Economists usually group macroeconomic statistics in one of three categories: leading, lagging, or coincident. In terms of the forex market and this article, in particular, we shall touch base on what the leading indicators for economic growth are.
If you want to make careful and informed decisions when it comes to trading, then it’s imperative that you take note of the leading economic indicators. This is because these metrics will give you insight into what is currently happening as well as giving you a glimpse of what will happen with the economy. These indicators even take into consideration things such as GDP or job growth.
Having these useful tools in your arsenal can provide solid foundations for viable predictions of upcoming changes in the US economy, way before they even actually happen! While they may give you the closest predictions, they are not always spot-on or accurate all of the time. These are best fitted for using along with other indicators that provide helpful insights on possible movements in the economy.
What makes up the leading economic index?
The index for leading economic indicators has been created by the US Conference Board as a part of a greater and grander analytic system that aims to show inflection points in economic growth. In a nutshell, it was made with the intention to summarise future economic performance through its goal is showing inflection points in economic data. This is particularly useful if you want to get a feel as to where the economy is gearing to turn to.
For those that are unfamiliar with the leading economic index, all the readily available information may tend to be overwhelming. To help break it down for you, we have listed all of its parts so that you know which elements to look out for next time:
- Average consumer expectations for business conditions
- Average weekly initial claims for unemployment insurance
- Interest rate spread, 10-year Treasury bonds less federal funds
- Average weekly hours, manufacturing
- Leading Credit Index
- ISM Index of New Orders
- Stock Prices
- Building permits, new private housing units
- Manufacturers’ new orders, nondefense capital goods excluding aircraft orders
- Manufacturers’ new orders, consumer goods, and materials.
All of these 10 components of the leading economic index work together to give you the most accurate picture as to the trajectory of the economic growth of a certain country.
Now that you have an idea as to what the components are, you may be wondering, what do they actually mean? Generally, many if not most of the components of the leading economic index refer to employment. This is particularly exemplified by average weekly hours in manufacturing or even unemployment claims which are just two of the employment components.
However, in spite of the two aforementioned components being incredibly helpful, as a leading economic indicator for forex trading, they are essentially lagging. Logic follows that when a company or an employer starts laying off people, it means that their business is at a precarious position.
The second type of grouping included is that of components connected to actual orders. The orders are exemplified by manufacturers’ new orders for consumer goods and materials, the ISM Index or new orders, or even manufacturers’ new orders of nondefense capital goods excluding aircraft orders. This last component is then for business capital investment.
The next component that we will touch on is for US Housing Building Permits which gives information regarding future housing developments. Before properties are actually constructed, a requirement is to receive a building permit first. This allows construction to move forward without any worries!
Next in our Leading Economic Indicators, you have to consider stock prices. The leading economic index that we have utilises the S&P 500 index prices in order to gauge market sentiment. It also uses a leading credit index in order to determine whether or not people are increasing or decreasing their borrowing. This component is important because it can give you an idea as the future spending tendencies of people.
The index also features a yield curve. The yield curve will be able to tell you if borrowing costs have a tendency to increase or decrease over time. The general rule here, though, is that a borrower tends to pay higher interest rates when it comes to longer tenor loans. This is mainly due to the reason that uncertainty increases the longer that the time passes. For those who are keen on trading debt or currencies, this is definitely something you have to keep an eye on.
You will be able to figure out if the yield curve is inverted if the short term yields are higher compared to long term yields. This only denotes that the investor believes there to be more risk in the short-term, compared to the long-term. In plain terms, this inverted yield curve denotes recession.
The last, but definitely not the least, of the components is the average consumer expectations for business conditions which take into consideration sentiment. This may not sound like much but trust us: it can do great if you’re aiming for short term movements in economic activity.
How should you use the Leading Economic Indicators for trading?
The leading economic index features 10 subcomponents that you may gauge before they are even released. Similar to any other economic data that is consistently released, having the leading economic index in your toolbox can present you with many opportunities. Since some of the 10 subcomponents can be analysed by veteran analysts in advance, you will not be getting any sudden surprises.
If you know what to look for in the leading economic index, then you are well on your way to mastering this index to make even better trades!
In summary, the leading economic index is a set of individual data points that can be used to predict any movements or changes to the economy. It can be used as a guide for forex traders and economists alike to foresee inflection points in the economy before they even actually happen. As we have mentioned this is one element of a traders arsenal and should be used in conjunction with a solid understanding and a strategic approach. To capture your piece of the financial markets, book a strategy call with one of our professional traders who will walk you through your own personalised success plan involving only 4 hours trading per week.
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Hopefully, you have enjoyed today’s article. Thanks for reading!
Have a fantastic day!
Nisha Patel
Live from the Platinum Trading Floor.