With so much data flooding our eyes and ears, traders often misinterpret what it all means. The biggest mistake is confusing the stock market for the economy. The stock market is one indicator of economic health; it is not the economy, nor is it THE indicator.
But in this micro world of trading and investing, traders tend to blur the relationship into one giant morass.
The stock market-economy relationship, explained
The economy is based on a country’s production and consumption of goods and services. Various tools are used to measure an economy’s health. They include unemployment, manufacturing, housing, bank loans, trade and deficits.
The stock market looks at the economic data and determines what is likely to occur in the economy down the road (usually 6-8 months out). It’s more of a predictive tool, and over the long-term, it is proven to be accurate. As a result, the stock market serves as a discounting mechanism for prices based on trends, patterns and certain economic data.
Why the economy is important to traders
Macro economic trends are important for traders follow, because they tip you off when the economy is about to turn up or down. If you pay attention, you’ll be in the right mindset and ready to handle whatever’s coming next. Because yes, you might need to prepare yourself for a bear market.
As much as traders may prefer a bull market economy, bear markets are a natural occurrence. Compared to bull markets, bear markets are short and can be quite painful. If you’re mentally prepared, you will be positioned to spot and act on good buying opportunities.
Look at the market action from December 2018 through February 2019. That short and painful bear market caught many off guard, especially because December is historically strong in the markets. Here at Explosive Options, we were prepared, and our portfolio is now up 27% YTD.
Like many things in life, the more you know, the better. This year, make it a point to follow the macro economic trends, and see how it changes your perspective.