The financial market is relatively similar to the traditional open air market where demand and supply are the key drivers of the pricing. For instance, the price of a stock or commodity will go up if there is increased demand. A good example in today’s market is on the crude oil prices which are falling as supply from OPEC and non-OPEC countries increase. However, above the micro data, the macro environment plays a very significant role in determining the trading environment. As a trader, you should always understand the macro-economic information of any asset you go long or short on.
Why the macro matters
The macro environment determines the health of the economy. It simply represents the broader picture of the economy. If the country’s economy is on the rise, it means that people and companies are performing well financially which increases their purchasing power. If on the other hand the economy is sinking, it means that various sectors will be affected.
A good example is what is happening in China. In June, the country reported that their economy would continue growing but not at the rate which was anticipated by the market. Since China is the world’s biggest consumer, the implications in the financial market became severe. After the announcement, many companies which depend on the Chinese market such as Boeing and Apple have lost significantly. China has also devalued its currency against the dollar further accelerating the volatility of the market. The Chinese main index, the Shanghai Composite Index has lost more than 20% in the past one month.
As a trader, it is very important to stay abreast with the economic data of the assets you want to own. For instance, if you specialize in commodity trading, it is important for you to understand the macro information of countries that influence the demand and supply of gold. The same applies to currencies, bonds, indices, and stocks. For instance, if China is the largest customer of oil and their economy crumbles, the prices will come down so that Chinese people can afford the commodity.
The most important economic indicators include: the Gross National Product (GNP) which measures the overall performance of the economy; Gross Domestic Product (GDP) which measures the total goods produced in a country by domestic and foreign companies; consumer spending which measures the level at which the public is spending versus saving; investment; and government spending. If all these metrics are positive, then this is an indication that the economy is doing well.
Industrial sector indicators
These indicators are important because they show the total output of a country’s plants, utilities, and mines which are significant in calculating the economic growth of a country. To a large extent, it determines the strength or weaknesses of a currency. For instance, the United States is a net exporter which has helped improve the strength of the dollar against all currencies.
Capacity utilization is a relatively important metric in the industrial sector indicators. It is established by dividing the total industrial output and the total production capability. A normal figure of capacity utilization is 81.5%. A figure above 85% shows that the economy is close to full capacity which precedes inflation. Other industrial sector indicators are: factory orders, durable goods orders, and business inventories.
In the financial market, inflation is a key indicator of how the economy is doing. In an environment of low interest rates, the purchasing power of people and companies is increased thus pushing high the inflation rate. A higher inflation rate leads to the tightening of the monetary policy. The key indicators to look up to are the: producer price index (PPI) which is compiled from the sectors that make up the economy; the consumer price index which measures the change in price of a fixed basket of shopping items people buy every day; Gross national product implicit deflator and the Gross domestic product implicit deflator.
The goal of the government is to create an environment where all people are employed or actively involved in boosting productivity. The two most important macro indicators in this regard are the non-farm payrolls, employment rate, and the unemployment rate. An increase in the non-farm payrolls indicates an improving economy which will lead to the strengthening of the currency, equities, and commodities.
Economic data is not the only macro issue traders need to look at. The geopolitical environment is very critical for the markets. A good example is on the Ukraine and Russia situation where Russia has continually worked to destabilize Ukraine. Russia is a key emerging market whose economy is partly dependent on oil. As a result of the crisis, countries such as the United States which enjoyed a good relationship with Russia reacted by putting in sanctions thus affecting the trade between the two countries. Therefore, American countries that depend on Russia such as McDonalds have continued to suffer decline in sales.
As a day trader or long term investor, these numbers need to be at your fingertips on a daily basis. The economic calendar is your best friend which you should always look on a daily basis as you crunch the numbers. It will help you determine when to stay on the side-lines or stay in the trade.