For the last decade, I’ve been analysing the economy with a technique called the Economic Clock. As a trained Technical Analyst, my view of decision making for trading shares was to analyse price and to disregard all other information. Whether that be Fundamental, Political or Economic. Reason being that Technical Analysis defines that all information is represented in price anyway. But several years into my career, and two major market crashes later, and I started searching for reasons why the major trends were forming.
Introducing the Economic Clock. Now, I’m not scholarly with a Ph.D in Economics. In fact, my degree in Business (Marketing) focussed on statistics of research results. This has paid dividends in providing me with an insight into reading information and interpreting results, but study of the economy is a completely different ball game.
Yet, I had studied economics at school and university and did have a basic understanding. There are some key rules you need to know, which I’ve outlined these in bullet form below:
- Economies move in cycles, referred to as the Business Cycle. Including periods of Expansion, Contraction, Booms and Recessions (or even Depressions). Basically, stock prices have a higher probability of rising in an Expansion and Boom phase.
- The stock market is a leading indicator to the Economic Cycle. Purchasing of stocks is in anticipation of what the company value will be in the future. In fact, it is approximately 6-months in advance.
- There are 5 key economic indicators which are the statistics that help define what stage of the business cycle the economy is in:
1. GDP or Gross Domestic Product, measures national income and output. Increasing GDP is good for the economy.
2. Unemployment rate, is the number of people actively looking for a job, divided by the labour force. Low Unemployment is positive for the economy.
3. Consumer Price Index or CPI (Inflation), measures changes in the price paid by consumers for a basket of goods and services. Low CPI will help with spending within the economy.
4. Retail Sales, is a data sampling of sales of a number of retail goods over a period of time. Increasing Retail Sales is positive for the economy.
5. Interest Rates is the central bank benchmark or overnight rate at which central banks make loans to commercial banks. Low Interest Rates helps spending within an economy.
For the beginner, trying to define intricate algorithms that calculate where the economy is shifting is far too much to take on. When I was introduced to the Economic Clock, I found this to be the simplest method to visually describe at what state the economy is in.
The following image is the Economic Clock.
- At 12 o’clock is a Boom.
- Between 12 and 6 is a contraction.
- At 6 o’clock is a Recession
- Between 6 and 12 is an Expansion
Dotted around the clock are the 5 key economic indicators. When data is released for each of these indicators, we plot the action on the clock. So, for example, let’s say Interest Rates were falling. We would draw a clock hand at 7 o’clock. If majority of the indicators are pointing between 6 and 12, then we would be in an Expanding Economy.
There are many other economic indicators that can be applied to the Economic Clock, to help further analyse the economy. We call this the Advanced Economic Clock, and it merely provides a deeper understanding of the state of the economy. Be aware that you will not always have the indicators grouped together. Therefore, you read the clock with a line of best fit. Majority of the indicators in the same quadrant will determine your analysis approach.
If you don’t have access to economic data, a free website to help you find the data you need is tradingeconomics.com
This is a simple method that I have used for many years, to determine what strategies to best adopt for certain economic market conditions. It’s an easy to understand and visually determine method, and I hope it helps you in your approach to trading.
To learn all about the Advanced Economic Clock and how to use Economic Indicators to determine the phase of the business cycle. Click Here to Register your Interest for our Stock Selection Mastery Course if you would like to learn more about analysing stocks and the economy.