CPI (Consumer Price Index) Explained

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Video Transcription:

Hello traders. Welcome to the news training course and the third module, News that Moves the Market Profitably Enough for Us to Trade. In this lesson, I’m going to talk about the Consumer Price Index or CPI. And the cool thing about the CPI is that we can trade the U.S. CPI as well as any other Consumer Price Index released that we see on the economic calendar on the same way.

CPI Explained

Now, let’s start by defining what the CPI is. The CPI measures changes in the price level of a market basket of consumer goods and services purchased by its households. This means that the CPI measures the buying power of consumers over a fixed basket of goods and services. So the CPI is one of the most commonly used statistics for identifying periods of inflation and deflation. Now on periods of inflation, the buying power of the dollar, let’s take the dollar as an example, the buying power of the dollar will decrease; and in periods of deflation, the buying power of the dollar will increase, okay? And when I say the buying power of the dollar, I mean the buying power of dollar over same item, okay?

Now, since the CPI measures changes in consumers’ prices of a fixed basket of goods and services, a rise in CPI in a short period of time denotes periods of inflation. On the contrary, a drop in CPI in the short term can be interpreted as a period of deflation where the buying power of consumer increases. Now, that’s what we were talking about. Consumer prices account for the majority of overall inflation so rising prices lead central banks to raise interest rates to keep the inflation contained. And remember what we learned on the interest rate lesson, an increase in interest rate or a hike in interest rate by the Central Bank is good for the currency, so a raise in CPI is good for the currency and brings immediate bullish pressure. On the contrary, a drop in CPI brings immediate bearish pressure to the currency.

Definition of the CPI

So what we’re going to do here is we’re going to read the economic calendar. And when the CPI number comes out, if it’s better than expected or better than last month’s number, we are going to try to buy the currency. And if we have a drop in CPI, we are going to try to sell this currency. It’s as simple as that. So the CPI numbers are very important for traders because of the implication behind them. By looking at these numbers, we can know if the economy’s healthy because of the increase or decrease of the consumer’s buying power over a fixed basket of products and services. Now, by now I think everybody understands what this means.

An increase or decrease in buying power affects directly the valuation of a currency because of the implication of the Central Bank’s actions, vis-a-vis, this increase or decrease in buying power. So this is very simple. An increase in CPI is good for the currency or valuates the currency because it implicates that we are in a period of inflation and the Central Banks will have to hike the interest rate.

Now, how are we going to trade it? First of all, remember that we are never going to front run the news. We are never going to buy or sell a financial asset minutes or seconds before the news release. The CPIs are very straightforward event and an increase in volume will bring large moves in a short period of time. We are going to use pending orders to trade this release, because normally, the CPI release comes by itself and there is nothing more scheduled on the economic calendar. So we are going to use buy and sell stops above and below the immediate range. We can expect 50 plus big moves when the CPI is released and we can trade the U.S. CPI as well as any other schedule on the economic calendar. So this mean that we can trade the Aussie CPI, the Canadian CPI, European CPI, etc.

Now on the next lesson, we are going to go through the actual price action to read the release and I’m going to show you how you will have traded it.

Adam

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Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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