Profession of a trader: traders of the market should know the main economic indicators

Igor Dombrovan, Managing Director of Saxo Bank in Russia

Professional traders follow those major economic indicators that affect the movement of exchange rates. It is also recommended that a novice trader should do the same.

Here is an example. If the major economic indicators in the United States are improving, the dollar is likely to appreciate because the demand for the dollar will increase. The opposite is also true: if the U.S. economy deteriorates, the dollar will decline.

This article discusses the following issues:

- What are the most important economic fundamentals?
- Why are interest rates so important?
- What effect does inflation have on interest rates?

Not all economic indicators are important

Globalization and technology have made information more accessible. That is why a currency trader must learn to ignore most information and be able to focus on the key points.

Many economic reports are not worth much attention. For example, Irish unemployment data is usually of less importance than unemployment in the United States. While Irish unemployment is undoubtedly important to Ireland itself, the U.S. economy has a much greater impact on the world economy, so investors pay particularly close attention to economic reports published in the United States.

Virtually all professional trading platforms, including Saxo TraderThe economic calendar is another important tool, where you can clearly see all upcoming events and publications and prepare for them accordingly. Another important tool is the economic calendar, where you can clearly see all upcoming events and publications and prepare for them accordingly.

Key macroeconomic indicators

The most important economic indicators can be divided into three groups:

- Interest rates,
- Economic Potential,
- Capital flow and trade flow.

Interest rates are the main economic indicator for the foreign exchange market. Currencies of economies with higher interest rates tend to be stronger than currencies of economies with lower interest rates. Investors are always looking for opportunities to maximize the return on their investments, and economies with high interest rates typically offer higher rates of return on investments.

Imagine you want to invest your money and you see two banks located on opposite sides of the street. The bank on the right is willing to pay 6% of your investment return. The bank on the left is only willing to pay 2% of return on your investment. Naturally, you will choose the bank that pays 6% because you want a higher return on your investment.

The same principle applies to economies and their respective currencies. If the return on your investment is 6% in the UK and only 2% in Switzerland, you will probably choose to invest in the UK.

Investing in the UK will affect the value of the British pound. The more people invest their money in the UK, the higher the demand for British pounds becomes. Increased demand, accordingly, increases the value of the local currency.

It is advisable to keep a close eye on the actions of central banks (interest rate setting organizations) to see if they are going to raise, lower or leave interest rates unchanged in the future.

Some of the most influential central banks include the following:

- U.S. Federal Reserve System (Fed),
- European Union - European Central Bank (ECB),
- United Kingdom - Bank of England,
- Japan - Bank of Japan,
- Switzerland - Swiss National Bank,
- Canada - Bank of Canada,
- Australia - Reserve Bank of Australia (RBA),
- New Zealand - Reserve Bank of New Zealand (RBNZ).

Inflation affects interest rates

To anticipate a central bank's next move, you need to keep an eye not only on its actions, but also on the economic indicators it favors.

One of the most important economic indicators for central banks is the following inflation. Inflation - is the rise in prices for goods and services. Today you will probably pay more for a liter of milk and a loaf of bread than you did 10 or 20 years ago.

For the best understanding of the mechanism of inflation, we can consider the following example: after the First World War, inflation in Germany began to grow at a furious rate. Due to the extreme economic instability, the German national currency depreciated sharply. To get a sense of how bad things got, let's analyze the price of a German postage stamp. In April 1921, to send a letter from one city to another cost about 0.6 German stamps. And in December 1923, i.e. only 15 months later, to send a letter from one city to another cost hundreds of times more. Of course, this is an extreme example, but it helps us realize that inflation will always be an integral part of our lives.

Moderate inflation is considered a natural by-product of economic growth. However, too much inflation can harm the economy.

Central banks are always on the lookout for possible increases in inflation. When inflation reaches unacceptable levels, they often take measures to ease inflationary pressures. Interest rates are a tool to control inflation. Central banks can curb inflation by raising interest rates. Traders watch inflation rates to see what central banks can do with interest rates. If inflation is rising, central banks are likely to raise interest rates, which will favor the currency representing that economy.

There are two main inflation indicators to watch for. They have different names in different major economies, but their essence is as follows:

Consumer Price Index (CPI) - an economic indicator that measures the cost of a typical consumer basket. The more money consumers have to spend on essential goods and services, the less money they have left for additional goods and services.

Producer Price Index (PPI) - an economic indicator that measures the cost of raw materials that producers need to produce their finished goods. If prices for producers are rising, they are likely to pass that increase on to consumer prices.

Thus, every novice trader needs to be able to understand the main economic indicators that affect the movement of exchange rates.