Investment is related to economy and economic conditions. The economic conditions prevailing in the economy have huge impact on the value of the investment as well as availability and opportunities for investment. So for you as investors it is important to understand the economic conditions. To this purpose, economic indicators serve well.
An indicator is usually an index or group of index that helps to predict future financial or economic trends. For example, the social and economic statistics relating economic activities, such as output, demand and supply figures of any product or service or inflation or index for industrial production (IIP) published by various departments of Indian government are such indicators that helps to understand the trend in the economy and future course for investments. Some of the popular indicators include unemployment rates, GDP, IIP, inflationary indexes and consumer confidence. Official indicators must meet certain set criteria.
There are three categories of indicators, classified according to the types of predictions they make.
Leading – These types of indicators signal future events. Think of how the amber traffic light indicates the coming of the red light. In the world of finance, leading indicators work the same way but are less accurate than the street light. Bond yields are thought to be a good leading indicator of the stock market because bond traders anticipate and speculate trends in the economy (even though they aren’t always right).
Lagging – A lagging indicator is one that follows an event. Back to our traffic light example: the amber light is a lagging indicator for the green light because amber trails green. The importance of a lagging indicator is its ability to confirm that a pattern is occurring or about to occur. Unemployment is one of the most popular lagging indicators. If the unemployment rate is rising, it indicates that the economy has been doing poorly.
Coincident – These indicators occur at approximately the same time as the conditions they signify. In our traffic light example, the green light would be a coincidental indicator of the associated pedestrian walk signal. Rather than predicting future events, these types of indicators change at the same time as the economy or stock market. Personal income is a coincidental indicator for the economy: high personal income rates will coincide with a strong economy.