Do you know the #1 reason why many retail traders underperform compared to their market counterparts namely – interbank dealers, hedge funds, financial institutions?
Studies suggests that despite retail traders having strong requirements to be well informed they are not. They do not anticipate returns on trades, lack trading acumen and are emotional when trading.
What stops traders from being better informed, improving their trading acumen or reducing emotional trades such as hope and wishful thinking?
The answer is – it’s not easy to make the connections between the economy, central bank actions and financial instrument prices.
However there are just 4 steps that simplify the process of making the connections between these three factors easier.
As a trader in the interbank market I relied purely on technical analysis for the first few years. Drawing trendlines, using technical indicators such as moving averages, MACD, RSI etc etc to predict returns in the FX markets.
Though I utilised technical analysis I never really understood the “fundamentals” behind the primary trend or reversal of trends; what these linkages between economic indicators, financial markets and central bank policy decisions were…
The 4 steps are –
Step 1 – Identify the price determinants of financial instruments
Step 2 – Understand how each economic indicator contributes to either economic growth or inflation (we use an economic map to demonstrate these connections)
Step 3 – Study the impact of each economic indicator on financial instrument prices
Step 4 – Make the connection between economic indicators, central bank’s monetary policy and financial instrument prices
“Market Analysis can be approached from either direction (Technicals or Fundamentals). While I believe that technical factors do lead the known fundamentals, I also believe that any important market move must be caused by underlying fundamental factors. Therefore, it simply makes sense for a technician to have some awareness of the fundamental condition of a market.” – John J. Murphy, Technical Analysis of the Futures Market
Second objective – Increase your financial intelligence by understanding markets
Did you ever read Robert Kiyosaki’s book ‘Rich Dad Poor Dad’? One of the important messages in Robert Kiyosaki’s book is that we can increase our financial wealth by increasing our financial intelligence . He mentions that financial intelligence is made up of four technical skills – accounting, investing, understanding markets and understanding the law. The goal of this course is to learn one of those essential technical skills – understanding markets.
The Use of an Economic Map
We make these connections between economic entities, factors, markets and central bank policies through the use of an economic map . The economic map helps us to understand how each small sub-component aggregates to the larger components, which in turn aggregate to the Gross Domestic Product thus giving us a wider perspective of how entities interrelate with one another.
Some of the economic indicators we will study are:
- The Quarterly GDP Report
- Car Sales Report
- Retail Sales Report
- Personal Income and Outlays Report
- Housing Starts
- Durable Goods Orders Report
- Factory Orders and Manufacturing Inventories
- Construction Spending
- Trade Balance Report
- Purchasing Manager’s Index
- Industrial Production
- Leading Economic Indicators
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