The Big Three Economic Indicators Jim Graham Traders are always trying to understand the factors economic parameters of options cause the market to rise and fall. The truth is that there are a multitude of factors, and millions of investors make decisions that impact the market every day.
Corporate earnings and news, political news, and general market sentiment can all move the market. But economic factors have the most influence on long-term market performance. There is a lot of economic data available on the US economy, and almost every day some economic report or another is being released. When reading these releases I always try to assess the importance of each item and how it fits into the current economic situation.
For the most important reports, especially those that may impact an industry that contains companies you economic parameters of options trading, it is often better to not rely solely on the analysis offered by financial journalists but to look at and try to understand the original sources.
Of all the economic indicators, the three most significant binary option is simply fast and profitable the overall stock market are inflation, gross domestic product GDPand labor market data.
I always try to keep in mind where these three are in relation to the current stage of the economic cycle. That gives me a framework to work with that allows me to estimate how any individual piece of economic data may affect these three indicators, and to then project its probable effect on the stock market as a whole. INFLATION Inflation is a significant indicator for securities markets because it determines how much of the real value of an investment is being lost, and the rate of return you need to compensate for that erosion.
So investors who buy stocks do so expecting they will get a return equal to or better than that risk premium adjusted by the inflation rate. So a higher rate of inflation means you should get a higher return for investments in the equity markets.
But the effect inflation has on the stock market is more complicated than that. So all other things being equal, a favorite phrase of all economistslow inflation is better for the market than high inflation.
There are many causes of inflation. But the single most important determinant of inflation is the output gap, which is the balance between supply and demand in the economy. When actual output is below its potential, inflation should be low because excess workers and unused plant and equipment are available.
The actual level of output is easy to get, and is measured by GDP. But potential output is harder to calculate and requires estimates to determine its value. So while the output gap is important to always keep in mind when interpreting economic data, its exact amount is never known.
For that reason it is not a realistic indicator for investors to use.
That is why a proxy is needed, so that you have a single number to estimate it. The Labor Department issues a CPI figure every month, measuring the increase in the price of a given "basket" of goods and services purchased by the average consumer.
That basket supposedly includes a number of items commonly purchased by all or most consumers, such as food, housing, clothes, transportation, medical care, and entertainment.
The total value of that basket is then compared to the same basket of goods a year later. The percentage increase in the price for these goods in one year is the inflation rate or, if the value drops as happened in Japan over much of the past decade, the deflation rate.
There are of course some problems with this measure. For one thing, the products rarely remain exactly the same, and it can be difficult to strip out how much of an increase is due to inflation, and how much is due to other factors such as improvements in quality.
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Also, the composition of what people buy changes over time. In fact, many of the goods now included were not even invented 20 or 30 years ago. Still remains the single best proxy available and, economic parameters of options least in the short- to medium-term, is the number that investors focus on when making their decisions.
GDP is the dollar value of all goods and services produced by a given country during a certain period.
It is measured by either adding all of the income earned in an economy, or by all the spending in an economy. Both measures should be roughly equal. Gross domestic income includes wages and salaries, corporate profits, interest collected by lenders, and taxes collected by governments. GDP domestic expenditures includes consumer spending, housing investment, government spending, business spending investment in factories, equipment, and inventoryas well as foreign spending on our exports minus our spending on their imports.
With so many individual components affecting GDP and through the output gap, inflation you can see how easy it is for the number of economic reports to mushroom. GDP affects the stock market through its effect on inflation, as well as through its use as a key indicator of economic activity and future economic prospects by investors.
Any significant change in the GDP, either up or down, can have a big effect on investing sentiment. If investors believe the economy is improving and corporate earnings along with it they are likely to be willing to pay more for any given stock.
If there is a decline in GDP or investors expect a decline they would only be willing to buy a given stock for less, leading to a decline in the stock market. They consequently stop spending as much. Since consumer spending represents around two-thirds of GDP, a small change in consumption exerts a significant effect on GDP. This means that as the stock market falls, it causes GDP t9 fall even further, which further intensifies the downward pressure on the stock market.
The key indicators most investors focus on here are total employment and the unemployment rate.