Hacking Trading through Economic Indicators

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Introduction
261
23.7

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Why a course on economic indicators?

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What they have to say…..
“On September 16, 1992 he used
economic indicators to short against the
over-valued British pound and pocketed
$1 billion on the deal ”
— George Soros
Billionaire Hedge Fund Manager,
27th Richest Person in the World
“Emphasized the importance of systems
in investing and used economic data to
manage funds with 21% average
compounded return over past 30 years ”
— Ray Dalio
Founder and co-chief investment officer,
Bridgewater Associates, #1largest hedge
fund in the world
“On October 19, 1987 the Dow plunged
22.6%. Using economic indicators , the
value of Zweig Forecast portfolio climbed
9% on ‘Black Monday’. ”
— Martin Sweig
Billionaire Hedge Fund Manager,
Author ‘Winning on Wall Street’
“Using economic data, he correctly
predicted the US subprime mortgage
crisis and used Credit Default Swaps
which made his hedge fund $15 billion in
2007 ”
— John Paulson
Founder and President Paulson & Co.,
Networth of $13.5 billion as of 2014

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How it has performed in live trades ?
Market Situation: 24th July 2015 - The market had been running up for several days. The Nasdaq QQQs
had made a new high, but the Dow and S&P 500 failed to confirm. The earnings of some Dow
components were weaker than expected and the market gapped down on 20th July. I short the Dow, and
I'm starting to look for areas to short the S&P as well as the QQQ. I know the market is at a tipping
point. On 24th July, New home sales fall to 482k, when the expectation was 543k. Also, the Fed leaks that
rates will be hiked to 0.35% from 0.25% by Dec 2015. The market accelerates to the downside.
Strategy: I short the QQQ and the S&P 500 with puts on the market. I make 75% return on investment
($2000) in 3 days, not bad.
Market Situation:17th Dec 2014 - The market had been trading down for several sessions. It needed an
incentive to bounce. On 12/17/14 that incentive came in the form of a better than expected CPI
report. The expectation was for -0.1, but the actual came in at -0.3, the market had put in a bullish
engulfing pattern.
Strategy: The next day I got long the S&P with some calls. I made $1500 that week.
Market Situation: 16th Oct 2014 - The market had been oversold and trading down for several
days. The question on everybody's mind, "Is this the beginning of the bear market?" Pundits had been
talking about it for days. Then unemployment claims dropped from 284k to 264k and we saw a strong
bullish pattern on the chart.
Strategy: I bought call options the next day for a $900 profit in 3 days.

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System of economic indicators
“Almost everything is like a machine. Nature is a machine. The family is a machine. The life
cycle is like a machine. My constant goal is to understand how the economic machine works.
And then everything else I basically view as just a case at hand.”
- Ray Dalio
• We wanted to develop a system with 2 points of focus:
• Consistent Returns > Returns from US stock market
• At the same time, System Risk < Risk in US stock market
• Studied the strategies of great investors /traders/ hedge fund managers
• Martin Sweig, Ray Dalio, Mark Boucher, Peter Lynch, Warren Buffet
• Researched multiple strategies and investment techniques keeping in mind risk-return parameters
• Arrived at a simple rule-based system, that can be traded in 30 minutes a day
• Rigorously back-tested the system with 30 years of historical data
• Applied the system’s methodology to benefit in live market trades

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Behind the system
However, It is important to understand why the system works to be a master
“ The market novice constantly searches for ‘magic’ systems that will
deliver a fortune. The master tries to develop the necessary skills and
insight into markets and economics to consistently see what
methodologies will work in the forthcoming environment.”
- Mark Boucher
We believe in transparency and integrity
Understand why the system works, before applying the system
Test the system out, and challenge us.
We can learn together and make the system more robust as time passes
*We know back-testing is subject to optimization bias. But that is the only metric to measure performance of a system over long run.

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Modules
Economic Indicators - Introduction
Implications for the market
Hacking Trading through a System of Economic Indicators

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Module - I
Hacking Trading through Economic Indicators

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Economic Indicators
Definition: Investopedia defines economic indicators as “ A piece of economic data, usually of macroeconomic
scale, that is used by investors to interpret current or future investment possibilities and judge the overall
health of an economy.”
Agencies Involved
Federal Reserve Board
Conference Board
Bureau of Labor
Statistics
US Census Bureau
Bureau of Economic Analysis

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Gross Domestic Product

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GDP = C + I + G + X - M
Consumption
Investment Government Expenditure
Export
Import

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GDP and Economic Indicators
“GDP” Gross Domestic Product: The aggregate value of goods and services produced within the U.S
Economic Indicators - GDP
Consumption
58%
Investment
16%
Government
15%
Trade
11%
Consumption
expenditures represent
more than one-half of
GDP
Quarterly GDP
Initial
Unemployment
Claims
Purchasing
Manager’s Report
Employment
Industrial
Production/
Capacity Utilization

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‘C’ Consumption
Services
54%
Non-
durables
31%
Durables
15%
Consumption: The most important sector in the US
economy - accounts for 58% of GDP
Consumption Basket
Economic Indicators - Consumption
Consumption
58%
Investment
16%
Government
15%
Trade
11%
Car Sales Retail Sales
Consumer
Sentiment
Personal
Income

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‘I’ Investment
Investment: The next largest component in the US economy
- accounts for 16% of GDP
Investment Basket
Economic Indicators - Investment
Consumption
58%
Investment
16%
Government
15%
Trade
11%
Housing Starts
Durable
Goods Order
New Home
Sales
Construction
Spending
Factory Orders
Business
Inventories

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‘G’ Government Spending
Investment: The third largest component in the US economy
- accounts for 15% of GDP. Consists of Federal, State and City
funding
Government Spending Basket
Economic Indicators – Govt Spending
Consumption
58%
Investment
16%
Government
15%
Trade
11%
Construction
Spending

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‘X-M’ Trade
Trade: Net result of exports minus imports - accounts for
11% of GDP. Exports < Imports – Trade Deficit
Trade Basket
Economic Indicators
Exports Imports
Consumption
58%
Investment
16%
Government
15%
Trade
11%
Trade Balance

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Inflation
Inflation is a measure of a general increase in price level and decrease in purchasing power of the dollar
Economic Indicators - Inflation
CPI Inflation (year-on-year) in the United States from 1914 to 2000Inflation - Silently robbing you of purchasing power since 1913
Producer Price
Index
Consumer Price
Index
Nonfarm
Productivity

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Fed Funds Rate
• Interest Rates at which banks lend to one another
for overnight use of excess reserves
Fed Funds Rate
• Interest Rate at which banks can borrow from the
Federal Reserve to meet reserve requirements
Discount Rate
• Minimum Interest rate below which banks cannot
lend to their customers
Prime Rate

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Yield Curve
To fight the slowdown Fed lowers the
discount rate
This causes an increase in the spread of the
yield curve
As the yield curve steepens banks have more
of an incentive to borrow on the short term
market and lend long to the bond market
This compensates for the long term risk
Yield Curve is a curve that shows interest rates/ yields on bonds across different maturities usually 3 month, 2
year, 5 year and 30 year US treasury bills.

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Economic Calendar
Link: http://www.bloomberg.com/markets/economic-calendar

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The Super Six
GDP
Fed
Funds
Rate
Cap.
Util.
Employ
ment
CPI
Yield
Curve
SYSTEM

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Module - 2

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• Broadest measure of economic activity
• GDP is “how the nation keeps score”
Frequency: Quarterly (revised monthly) Available: 21st – 30th of the month
Stock Market Bond Market
“On May 29, 2015 the quarterly GDP
dropped -.7%. The real problem was
that corporate profits which are a
component of GDP fell 5.9%.”

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GDP vs S&P 500
On May 29th 2015, GDP dropped -
0.7%, corporate profits dropped
5.9% that lead to an 8 day sell-off
of 2.3%

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GDP vs Bond Market
On 28th Aug 2014, the market expectation for the GDP was 3.9%. The actual number came in better
than expected at 4.2%. Bonds reacted negatively.

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• Standard measure of inflation in the economy
Consumer Price Index
Frequency: Monthly Available: 15th – 21st of the month
“On December 17, 2014 the core CPI dropped -
0.3% when the consensus estimate was for -0.1%.
This was the lowest drop in 6 years fueled by low
energy prices. This sparked an eight day rally in the
S&P.”
Consumer
Price
Index (CPI)
Consumer
Price
Index (CPI)
?
?

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CPI vs S&P 500
On December 17, 2014 the core
CPI dropped -0.3% when the
consensus estimate was for -
0.1%. This was the lowest drop in
six years fueled by low energy
prices. This sparked an eight day
rally in the S&P.

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CPI vs Bond Market
The market had run up for several days prior to the +ve CPI report on 17th Dec 2014. After some
initial profit taking, the market proceeded to continue the rally in the bond market

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• Very useful to measure the business cycle because it
measures the extent to which the stock is being used
Industrial Production / Capacity Utilization
Frequency: Monthly Available: 14th – 17th of the month
“On March 17, 2014, the Industrial Production climbed
higher than expected, growing 0.6% vs 0.2% expected, and
also Capacity Util. rates came better than expected. The S&P
500 went up by a tremendous 0.96% and the Dow Jones
Industrial Average did even better at 1.13%.”
Industrial
Production/
Capacity
Utilization
Industrial
Production/ /
Capacity
Utilization

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Capacity Utilization vs S&P 500
On March 17, 2014, the Industrial
Production climbed higher than
expected, growing 0.6% vs 0.2%
expected, and also Capacity Util.
rates came better than expected.
The S&P 500 went up by a
tremendous 0.96% and the Dow
Jones Industrial Average did even
better at 1.13%.

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IIP vs Bond Market
The bonds as expected reacted negatively to the news, and assumed a downward trend

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• 2nd most important economic indicator after GDP
• Can be used to predict other indicators like industrial
production numbers
• First complete economic indicator – sets tone for the
rest of the month and a major market mover
Employment Report
Frequency: Monthly Available: 1st – 7th of the month
“On October 16, 2014 the unemployment claims
dropped from the previous 284,000 to 264,000, while
the expectation was for 286,000. The significant drop
in jobless claims fueled a rally of 14.9% in
approximately 50 days, from Oct 16th to Dec 5th.”
Employment
Report
Employment
Report

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Employment Report vs S&P 500
On October 16, 2014 the
unemployment claims dropped
from the previous 284,000 to
264,000, while the expectation
was for 286,000. The significant
drop in jobless claims fueled a
rally of 14.9% in approximately
50 days, lasted from October
16th to December 5th

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Employment vs Bond Market
Bonds on the other hand saw the news as negative, signaling that the economy was doing better than expected
and perhaps giving the hawks in the Fed the ammunition to justify a rate increase.

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• Very important tool used by the Federal Reserve to
keep the economy in balance
• Has a ripple effect across entire economy – ranging
from stocks, bonds, consumer and business spending,
inflation, and recessions
Fed Funds Rate
Frequency: 8 times per year (FOMC meeting) Available: 40 days after the previous FOMC meet
“On September 18th , 2007 the Fed reduced the rate
from the previous 5.25% to 4.75%, while the
expectation was for 5%. The significant drop in Fed
rate fueled a rally of 4.0% in approximately 24 days,
from Sep 18th to Oct 12th.”
Fed Funds
Rate
Fed Funds
Rate

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Fed Funds Rate vs Equity Market
• Changes in interest rates → Borrowing Cost → Corporate Profits → Equity Prices
When corporate
profits rise or fall,
stock prices tend to
do the same

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Fed Funds Rate vs Bond Market
• As Fed interprets economic data and makes policy changes, fixed income market is impacted first
• Fixed Income Market has a direct relationship with interest rates (primary tool that Fed uses to adjust
liquidity in the market)
8% $1000
Suppose the US treasury issues a bond at prevailing interest
rates, say 8%...
6%
$1200
10%
$800
If the interest rates fall to 6%....
The price of the bond rises because its return is higher than
that of a new bond
But if interest rates rise to 10%....
The price of the bond falls because its 8% return is less
attractive

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• Slope of the yield curve is a reliable predictor of future
economic activity
• The shape of the yield curve – normal, inverted or flat
- is used to denote the health of the economy
• It significantly outperforms other indicators in
predicting recessions 2 to 6 quarters ahead**.
Yield Curve
Frequency: Daily Prob. of US recession predicted by Treasury Spread*
Slope of Yield
Curve
Slope of Yield
Curve
*Treasury Spread = 10 yr bond rate – 3 month bill rate **By Arturo Estrella and Frederic S. Mishkin, Current Issues in
Economics and Finance (2) 7, June 1996 – Federal Bank of New York

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3D Yield Curve

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Monetary Policy in action
The Fed sets in motion changes in monetary policy based upon economic indicators that causes a chain reaction. One view
of this is a wheel constantly in motion.
Monetary
Policy
Federal
Reserve
Open
Market
Operations
Bank
Reserves
Money
Supply /
Interest
Rates
Consumer
and
Business
Spending
Economy /
Inflation

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Monetary Policy in action
Another view of the changes in monetary policy would be the wave. It is the ripple in the water that sets in motion the wave
which causes the start or stop of a new business cycle.

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Liquidity Cycle

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Module - 3

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Rule 1: Capacity Utilization
Buy S&P 500 when the 12-month rate of change (RoC) of Capacity Utilization
> -1.75%. Exit S&P when RoC < -1.75% and Invest in 3-month T-BillRule
Capacity Utilization Index usually leads the stock market. As the demand in the economy starts
decreasing, less goods are produced due to the slack demand and the use of industrial machinery goes
down which eventually shows in the S&P500
Logic
S&P 500
Our Strategy
1967 – 2015 (48 years)
S&P 500
Our Strategy
A gain of 1 Mn Dollars at the same risk
* All returns are compounded annualized returns
* Left vertical axis represents S&P 500 *Right
vertical axis indicates Cap. Util. in % terms
50
55
60
65
70
75
80
85
90
50
250
450
650
850
1050
1250
1450
1650
1850
2050
1967
1970
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
2012
2015
S&P 500 Cap Util

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Rule 1:Portfolio Performance
-0.25
-0.2
-0.15
-0.1
-0.05
0
0.05
0.1
0.15
50
550
1,050
1,550
2,050
2,550
3,050
3,550
4,050
CapUtilRoCYoY(in%)
PortfolioValue(in$'000)
S&P Portfolio Our portfolio Cap. Util. RoC YoY

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Rule 2: Yield Curve
Buy S&P 500, 4 months later, when the 12-month rate of change (RoC) of diff. between
30-yr T-bond & 3-mo T-Bill <2x. Exit S&P when RoC > 2x and Invest in 3-month T-BillRule
A rapidly rising yield curve, after an inversion, denotes a market which is about to hit it’s peak . That is
the time to sell high and get back in the market only when it is near its low. However, the yield curve
leads the market by a gap of 4-months, hence a 4-month prior number is used to apply the rule.
Logic
S&P 500
Our Strategy
1977 – 2015 (38 years)
S&P 500
Our Strategy
-6.00
-3.00
0.00
3.00
6.00
9.00
12.00
1.00
5.00
25.00
125.00
625.00
3,125.00
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
2010
2013
S&P 500 Diff 30 yr to 3 month
* Left vertical axis represents S&P 500 –
logarithmic scale *Right vertical axis indicates Diff
between 30yr and 3-mo T-bill in % terms

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Yield Curve Inversions Mark Stock Market Peaks

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-30.00
-20.00
-10.00
0.00
10.00
20.00
30.00
-
1,000
2,000
3,000
4,000
5,000
6,000
1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
RoCYoYofDiffbetween30-yrT-bondand3-m0T-bill
Thousands
S&P Portfolio Our portfolio RoC YoY Diff between 30 yr T-bond and 3-mo T-bill

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Rule 3: Unemployment Rate
Buy S&P 500, when the 12-month rate of change (RoC) of Unemployment Rate <4% or
>30%. Exit S&P when 4% < RoC < 30% and Invest in 3-month T-BillRule
During periods of recession, the unemployment rate starts increasing at a rapid pace, and gives a
signal to exit the falling S&P. However, unemployment reaches its peak when the market is at its
lowest and is a great indicator to buy low into the market and exit near its high
Logic
S&P 500
Our Strategy
1967 – 2015 (48 years)
S&P 500
Our Strategy
* Left vertical axis represents S&P 500 –
logarithmic scale *Right vertical axis indicates
Unemployment Rate in % terms
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
18.0
20.0
1.00
5.00
25.00
125.00
625.00
3,125.00
1967
1971
1975
1979
1983
1987
1991
1995
1999
2003
2007
2011
2015
S&P 500 Unemployment Rate (in %)

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-100.0
-80.0
-60.0
-40.0
-20.0
0.0
20.0
40.0
60.0
80.0
100.0
-
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
12-MonthRoCUnemploymentRate(in%)
Thousands
S&P Portfolio Our portfolio 12 - Mo RoC Unemployment Rate

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To get access to the full system…
To get access to the entire system for Hacking Trading go to Udemy Course:
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About the Course
• 64 lectures
• 2 Hours of Video
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Available for FREE [100% Discount] Save $199
for limited time [till 8th Jan 2016] only!

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Udemy Course
What all do you get from the course ?
• Learn from the strategies of the most successful hedge fund managers - George Soros, Ray Dalio, Martin
Zweig, Mark Boucher, etc.
• Decipher how the economic machine works and use economic data to your advantage
• Track economic indicators using free tools (Barron's, Federal Reserve Bank of St.Louis, Yahoo Finance, etc.)
available on web
• Choose the right economic indicators (GDP, CPI, Fed Funds Rate, Yield Curve) that impact the stock market
• Learn back-tested trading strategies that yield nearly double the return as compared to S&P 500 Index
• Develop a profitable system to generate significant profits trading the stock market in just 30 minutes a day
• Get in-depth exposure to systems used by Wall Street pros to convert 100 thousand dollars to over 15 million
dollars in less than 48 years

Hacking Trading through Economic Indicators

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Hacking Trading through Economic Indicators