The Importance of Understanding the Markets

22fin290913Do you need to obtain a good working knowledge of the financial markets in order to execute spread bets well? Although such a goal is definitely desirable, it is not totally essential. However, any investment of time and energy you expend acquiring such a sound appreciation will provide you with great insights and benefits by providing you with an edge. After all, knowledge is power. For instance, you will then be able to devise and implement strategies based on fundamental analysis proficiently.

Although important developments that occur on the financial markets are normally restricted to brief statements on TV news channels and in newspapers, you must acknowledge that they have serious impacts on everybody. For example, major economic events can directly influence governments, businesses and individual citizens.

For instance, a sharp decline in the Dow Jones Industrial Average can cause the capitalization of many firms to plunge despite the fact that they were not the primary cause of such an event. Consequently, whenever the stock of a company slumps that this will adversely influence its ability to secure additional financial backing, if required. In fact, you will discover that developments on the financial markets can influence many facets of everyday life.

However, you can exploit such features to enhance your spread betting activities. For example, by acquiring a good understanding about the operation of the financial markets will enable you to produce strategies based on fundamental analysis. An example will now be presented to demonstrate how valuable this knowledge can be.

 

The Basis of a Fundamental Strategy

The Consumer Price Index (CPI) is a very important fundamental indicator that is utilized to monitor inflation and is often used by economists to assess the effectiveness of recent government economic policies.  This is because CPI supplies valuable insights into the price fluctuations of products and services purchased by a country’s public and businesses.   In addition, governments analyze CPI trends in order to generate monetary policies which are then used to determine economic strategies. Consequently, if you intend to make fundamental analysis a central part of your spread betting trading then you are well-advised to monitor and evaluate CPI. The following steps will help you understand how best you can do this.

 

Step 1 – What is the CPI?

The CPI represents that average price change over a set time period of a basket of defined consumer goods and services. The cost of this basket is determined by calculating the monetary amounts that the citizens of a nation had to spend to order to buy the items comprising the basket. For instance, the USA has established a reference basis for the CPI using the statistics gained for purchasing the said basket during the years 2005 through to 2006.

The postings of the CPI are than compared to that figure. For instance, if the CPI posts a new value of 120 then this means that the cost of the market basket has risen by 20% whereas an 80 figure would indicate a drop of 20%. You must appreciate, however, that although the CPI is not an exact value it is a good indication of the current trends produced by the changing value of typical household spending. Consequently, CPI can be utilized as a guide to predict the future appreciation or depreciation of a country’s currency.

 

Step 2 – What does CPI represent?

The CPI figure represents a category of goods and services that are purchased and consumed by the population and businesses of the applicable nation. The main categories that comprise the CPI are as follows:

•    MEDICAL CARE (eye care, hospital services, prescription drugs, medical supplies, doctor services and eyeglasses, etc.)

•    RECREATION (pet products, sports equipment, televisions, toys and pets, etc.)

•    EDUCATION AND COMMUNICATION (telephone services, computer software, college tuition and postage, etc.)

•    FOOD AND BEVERAGES (coffee, chicken, wine, full service meals, breakfast cereal, milk, etc.)

•    HOUSING (fuel oil, bedroom furniture, rent, etc.)

•    APPAREL (women’s dresses, jewelry, men’s shirts and sweaters, etc.)

•    TRANSPORTATION (gasoline, motor vehicle insurance, cars, airline fares, etc.)

•    OTHER GOODS AND SERVICES (haircuts, funeral expenses, tobacco and smoking products, etc.)

The fluctuations of CPI that are recorded on either a monthly or yearly basis are normally expressed as a percentage. For example, if you observe that the CPI has decreased by 2% since last month then this means that the average price of the market basket has decreased by 0.02 of its previous month’s value.

This percentage change in the CPI is called the inflation rate of a country. For instance, if the CPI increased in value by 3.5% over a twelve month period then the inflation of the applicable nation would have risen by 3.5 percent. To understand this effect, imagine that our market basket cost $1,000 at the start of the year. If the annual inflation for the year was 5% then the same basket of items would cost $1050 at the year close.

 

Step 3 – The impact on National Interest Rates

Many spread betting experts and economists use the CPI postings as a method to determine the potential for changes in a country’s interest rates. This is very important because any future changes in interest can have a dramatically effect on the amount of foreign investment a country receives. In addition, the carry trade of the applicable currency will also be affected. These two factors can seriously influence the value of a nation’s currency against those of other countries. This is why you must make efforts to monitor these parameters if you intend to use fundamental analysis as a major part of your spread betting trading.

For example, if an inflation number is posted at a higher value that the one that has been anticipated by the market then economists and central banks would view such a development has a strong indication that the applicable country will raise its interest rate in the near future. As such a development would cause a serious increase in the flow of foreign investment into that country you could then well witness a surge in value of its currency against those of other nations.

In contrast, a weaker CPI posting would have the opposite effect causing the demand and the value of a currency to plunge. You must also realize that trying to trade a negative CPI posting can be more complex than trading a positive change. This is because although a positive CPI increase is very indicative of future bullish action, a CPI decline does not always support bearish developments.

 

Step 4 – Taking precautions

If you attempt to trade important fundamental events such as the release of CPI figures then you must always adopt caution. This is because such events can generate very volatile trading conditions on the spread betting markets that are capable of producing violent changes in price.

Quite often you will find that the price of an asset will accelerate sharply in one direction only to reverse its direction completely minutes later. Such movements are normally caused by traders making snapshot decisions based on the headline information associated with the CPI release only to reverse their opinions shortly after they have made a more serious study of the details.

In addition, the markets will make very dramatic moves if the release figure differs significantly from the one they expect. You could observe price movements of hundreds of points in minutes should this happen. This is caused because the CPI is a representation of inflation which has a great bearing on the future likelihood of interest rate changes.

Consequently, you should avoid such events, especially if you are a spread betting novice because you could suffer significant losses if you do not know what you are doing. Instead, you should wait until about 30 minutes before opening any new spread bets. This is because the event would have then settled down and you will be in a better position to benefit from the true effects of the release.

You can definitely increase your chances of obtaining consistent profits from your spread betting trading if you design a trading strategy using the concepts of fundamental analysis.

 

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