Gross domestic product (GDP) is one of the most widely used terms in the financial and business world. It is often mentioned by traders, analysts, CEOs and other market players when they discuss the current trend in the market, whether it is one of panic or of euphoria.
But what is GDP and how can it be used to shape and influence your trading or investment decisions? Let’s start by establishing a clear understanding of what GDP is.
What is GDP?
Though definitions may vary depending on the economist being consulted, most definitions refer to GDP as the total value added to a country through the production of goods or services within a given timeframe. This includes all income from production, total expenditure on final goods and services, as well as minus imports.
It is for this reason that GDP is often used to measure the size and health of an economy, making it more comprehensive in comparison to other measures such as industrial production and wages.
However, it is far from perfect. There are several limitations to using GDP as the only indicator of an economy’s performance. For example, it does not measure the happiness, well-being, or health of a country. Neither does it account for the environmental costs of economic growth. Furthermore, it does not tell us much about the country’s economic distribution and concentration. Most importantly, it does not tell us if the income created from GDP stays within the country to benefit its citizens.
Having established a clear understanding of GDP, let’s take a look at how investors and traders can use this to their advantage.
The impact of GDP on currency
GDP provides an indication of the economic health of a nation, and this will invariably have an effect on the performance of its currency in the global foreign exchange (forex) market. Currency traders take a keen interest in GDP data as it can be used to indicate economic growth or contraction in a country.
When GDP is increasing, currency traders often look for currencies associated with higher GDP rates as they believe that interest rates will remain the same, since prices typically increase with good economic growth. To prevent inflation, central banks will raise interest rates. On the other hand, when GDP is reported to be lower than expected, forex traders will begin to sell off the national currency in anticipation of potential losses.
It is clear that forex traders are aware of the importance of GDP data when it comes to forming their trading strategies.
GDP and stock trading
GDP and the prices of stocks and shares are also closely linked. Positive GDP figures are generally seen as a good sign of economic health, and when this is seen in real-time, the stock markets associated with that economy will also see an increase. For example, if the US government releases positive GDP data, it could have a positive impact on assets such as the S&P 500 and Tesla, even if the trader is located in another country.
What can traders do with GDP?
The two examples above demonstrate the importance of taking GDP data into consideration when forming trading and investment strategies. While it is not the perfect measure of an economy, and GNP is often a better indicator, it is still useful. A trader might spot a country with a higher than expected GDP figure, indicating that it could be a good opportunity to purchase assets associated with that country. On the other hand, a lower than expected GDP could signal a sell-off.
It is important to note that GDP should not be used as the sole factor when making trading and investment decisions. It should be considered as one of many inputs when forming a strategy. Additionally, it is important to note that there are three versions of GDP figures: final, preliminary, and advanced.
Despite its limitations, GDP data can still be very useful in shaping trading and investment strategies.
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