Some economic indicators create more noise than others—learn to create trading strategies based on how markets might react to economic data.
Innocently, you go online. You browse, you surf, you scan. Before you know it, you’re lost deep in cyberspace. Just like Tom Hanks stranded in an uninhabited island in the movie Cast Away, with nothing but remnants of a crashed plane and what’s left of the packages in the plane’s cargo. Where am I? How did I get here? And more important, how do I get out of here? You try to send out flare signals, you attempt to build a raft, but nothing works and you end up feeling lost and helpless.
The markets aren’t all that different. There’re so many data points that you don’t know which ones to use. You’re confident about when earnings and economic data will be released, but you have no idea how the markets will react to that data. The markets can feel random, and finding your way in that randomness can be a challenge. Add in all the competing opinions about how to beat the markets, and you can find yourself tangled in the “unknowing,” where any trade at all gets confusing, and staring at the screen becomes a popular pastime. But escaping from the market’s daily chaos is possible and desirable. All you need is a plan. And a review of a few trusted indicators.
Every day, a myriad of market and trading data info bites can drag markets up or down. The good news? For a wealth of information, you can access the Federal Reserve Bank’s massive economic database called “FRED” on the thinkorswim® platform from TD Ameritrade. But with so many factoids in one place, it’s easy to feel lost and not know how to get back home. Go in with a plan. Above all, used properly, FRED can help you create a strategy to tackle the market with a tad more certainty. Some economic indicators are more important than others. Let’s start off with four that will keep you engaged with the market, help you find possible trading opportunities, and get you to back to familiar territory sooner rather than later.
Gross domestic product (GDP). This is an important number that gives you a snapshot of the health of the economy. GDP can reveal the pace at which the economy is growing. Simply put, if GDP is up, people often feel good, they spend more, and that can be positive for equities. With a lower GDP, traders tend to move to bonds. Typically, GDP data affects broad market indices and blue-chip stocks, especially in the manufacturing and transportation sectors. Keep in mind that GDP is revised constantly, so by the time you get the data, it’s most likely going to lag the price movement of stocks.
Housing data. Here you’ll get a handle on whether consumer confidence, which churns the economy, is strong. Housing data comes in lots of shapes and sizes. You can review existing home sales, the S&P Case-Shiller U.S. National Home Price Index, the FHFA House Price Index, new home sales, and more. So, for instance, if existing home sales are up, especially if they’re higher than what Wall Street expected, it’s possible broader markets will move to the upside. Stocks of building-material companies, construction companies, and homebuilders are likely to be impacted by housing data.
Jobs data. This one’s a no-brainer—strong jobs numbers are generally a good indicator of a healthy economy. Important jobs data includes total employment figures and the unemployment rate. In this category, the monthly employment report for non-farm payroll is essential. A big surprise in any of these numbers could move prices up or down. Small-caps, banks, and financial stocks are often affected by jobs data.
Consumer spending and retail sales. It all comes down to how much people spend, and that’s a huge giveaway on how the economy is doing. For the most part, if people spend more, it’s good for the economy in the simplest terms. The University of Michigan’s Consumer Sentiment Index, the Consumer Price Index, and retail sales data are some of the data points you can use to figure out if consumers are spending more.
Once you know the kind of data you’re after, you can create watchlists of optionable indices, exchange-traded funds (ETFs), or equities that, historically speaking, tend to move before and after the release of economic data. Once you’ve got the watchlists in place, you can then apply FRED to your analysis. Let’s take retail sales as an example.
1. Economic EventOn your thinkorswim platform, go to the MarketWatch tab and select Calendar (Figure 1). You’ll see a list of things you can display on the calendar. Select Econoday event and you’ll see all the economic data that will be released by day, week, or month.
FIGURE 1: PENCIL IT IN.
When will retail sales be released? Employment data? Housing starts? Three clicks will get you there. Source: thinkorswim by TD Ameritrade. For illustrative purposes only.
2. All That DataLet’s say you notice that retail sales will be released soon. Head over to the Analyze tab and select Economic Data. You’ll see a list of several types of data, organized by categories (Figure 2). Browse through the list and find Retail Trade. Click on it and you’ll find more choices.
FIGURE 2: OH, SO ORGANIZED.
With so much available data, it’s a good idea to have a game plan. Figure out which information is important to you and go from there. Source: thinkorswim by TD Ameritrade. For illustrative purposes only.
3. Pick Your CategorySay you’re after e-commerce retail sales data. You’ll find a chart that shows the overall movement of this number for the past 15 years (Figure 3). Notice that ecommerce retail sales have been trending higher since 2000. At a broad level, this suggests that things, for now, are looking good in the ecommerce sector.
FIGURE 3: HOW’RE YOU TRENDING?
Select the ecommerce retail sales indicator and you’ll get a big picture of its overall historical trend. Source: thinkorswim by TD Ameritrade. For illustrative purposes only.
After all this data-crunching, let’s assume you know when retail sales are going to be announced, and you know the market forecast for retail sales. But you don’t know how the market will actually react. Economic data releases, just like earnings, are binary events—either something happens or it doesn’t. If you’re looking to trade on this information, you open a position based on what you anticipate the price movement will be. Pull up your watchlist of ecommerce retailers prior to retail sales releases. Review the implied volatility (IV) of those stocks, ETFs, or indices, so you’re well prepared before the release.
For example, you may find that before a data release, front-month contracts will tend to have higher IV. This could offer an opportunity to collect some premium. The number of days to expiration could be low, so you’ll have to worry about gamma risk since delta could become larger in the wrong direction. You may consider keeping your position small to reduce your gamma risk, or you may want to think about going further out and sacrificing the higher premium.
You may also find from your research that IV tends to decrease after data releases and you might open a position based on how large you believe the decrease will be. Engaging neutral strategies such as straddles could be a possibility. Another way to trade economic events is by making short-term directional plays using weekly options. Because weeklys have short life spans, consider contracts with expirations that coincide with data release dates. Yet, always be mindful of theta, since expiration will come pretty quickly on those weeklys and they can be subject to significant volatility. Profits on short options can disappear quickly and can even turn into losses with a very small movement of the underlying asset.
Markets are uncertain, and there’s no hard proof that studying economic indicators improves your ability to anticipate price movements. That said, information naturally makes you more aware of the bigger picture at critical points in time. Using FRED and other resources, you can more easily track the moving parts that can impact a stock’s direction and behavior.
Nothing guarantees a perfect trade. But you can perfect your research abilities every day you crank up your computer and feel empowered. Then you’re free to fire those signals and flag down that rescue plane. Trading can be a fascinating engagement, and life’s too short to get stuck in the middle of nowhere.
This short video gives a quick understanding of the Economic Data tab in thinkorswim:
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