If you want to know how the cost of living is changing, the CPI is one tool to check. Government agencies, businesses, investors, and traders use it to gauge inflation — the change in the prices of goods and services. Let’s take a look at CPI trading strategy.
The CPI (Consumer Price Index) is a measure of the average change over time in the prices paid by consumers for a basket of goods and services. It is calculated by the Bureau of Labor Statistics (BLS) in the United States and is used to measure inflation. The percent change in the index is used as a measure of inflation.
In this post, we answer some questions about the CPI. At the end of the article, you find a few backtests that look at the performance of S&P 500, bonds, and gold around the release of the CPI report.
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What Is CPI and How Does It Affect the Economy?
The CPI (Consumer Price Index) is a measure of the average change over time in the prices paid by consumers for a basket of goods and services. It is calculated by the Bureau of Labor Statistics (BLS) in the United States and is used to measure inflation.
Reported every month, the index is based on prices of a fixed basket of goods and services, with the prices of the goods and services in the base period set equal to 100. The current period’s prices are then compared to the base period’s prices to calculate the index. The percent change in the index is used as a measure of inflation.
CPI affects the economy by measuring inflation, which can influence monetary policy, interest rates, and the value of the currency. It also impacts wages, consumer spending, and economic growth and stability. High inflation can lead to economic instability, while low inflation can indicate a weak economy.
What Are the Benefits of Trading and Investing Around CPI?
Trading and investing around CPI can provide benefits such as insight into the economy’s overall health, potential investment opportunities, and the ability to make more informed financial decisions. It can also be used to identify potential trends in consumer spending, production, and price levels.
Investors use it to predict future inflation and interest rate changes, which can affect the value of stocks, bonds, and other financial assets.
How Can Investors Use CPI to Make Decisions?
Investors can use CPI to monitor changes in inflation, which can indicate future changes in interest rates, currency values, and economic growth, which can affect the value of stocks, bonds, and other financial assets.
Thus, it can help them to make more informed investment decisions, as they can use it to identify potential investment opportunities and trends in consumer spending and production.
What Risks Are Associated with Trading and Investing Around CPI?
The risk associated with investing or trading with the CPI is the same as every other fundamental indicator. Sometimes, it is difficult to know which direction the market might take upon the release of the CPI.
Also, it shows the short-term price change, which might not have any long-term effect on the market. To avoid making the wrong trading and investing decisions, it is advisable to use multiple indicators such as fundamental and technical indicators to better see the bigger picture before committing capital to the market.
What Strategies Can Investors Use to Take Advantage of CPI Movements?
Here are some strategies that investors can use to take advantage of the CPI report:
- Investing in inflation-linked bonds (ILB)
- Investing in commodities
- Investing in real estate
- Adjusting portfolio allocations
- Hedging through inflation swaps
- Using technical analysis to identify trends in CPI
- Investing in companies that have pricing power or the ability to pass on the increased costs to consumers
- Investing in companies that are less sensitive to inflation
What Resources Are Available for Those Seeking to Learn More About Trading and Investing Around CPI?
There are several resources for investors to use in learning about trading and investing around CPI. Some examples include financial blogs like this one, financial journals, and TV.
What Types of Assets Are Best Suited to Trading and Investing Around CPI?
Below are some assets suitable for trading and investing around CPI:
- Currencies: Inflation is bad for cash and this can provide opportunities for traders looking to catch the short-term price movements in the foreign exchange market.
- Gold: Investors can invest in gold amidst a high inflation environment to prevent their cash from being devalued.
- Stocks: Inflation is generally bad for stocks, but experienced investors can buy or short the stock market depending on the current economic outlook. This may present a lot of profit potential for investors.
How Can Investors Track Changes in CPI?
Investors can track changes in CPI by regularly checking the Bureau of Labor Statistics website for the latest data releases, and subscribing to news alerts or economic calendars to stay informed of upcoming data releases. They can also use financial news and data platforms like Bloomberg or Thomson Reuters to access historical and real-time data and analysis.
You can find it on the Bureau of Labour Statistics’ website.
What Are the Main Drivers of CPI Movements?
The major drivers of CPI are as follows:
- Changes in the prices of goods and services, especially food and housing
- Changes in taxes and subsidies
- Changes in production costs
- Changes in demand and supply
- Changes in exchange rates
- Changes in monetary policy
Additionally, changes in weather and natural disasters can also impact the prices of certain goods and services, and thereby affect CPI.
How Do Different Economic Sectors React to CPI Changes?
Different economic sectors react differently to CPI changes. Consumer discretionary sectors such as retail and travel will be affected if prices of goods and services rise, while basic necessities such as healthcare and education would still be in demand even if prices rise. Additionally, interest-rate-sensitive sectors such as real estate and banking may also be affected by changes in CPI.
How Can Investors Use Technical Analysis to Benefit from CPI Movements?
Investors can use technical analysis to identify market patterns and predict how different sectors may react to changes in CPI. This can help them make informed investment decisions and potentially benefit from changes in inflation.
Additionally, investors can use technical indicators such as the Relative Strength Index (RSI) and the Moving Average Convergence Divergence (MACD) to confirm trends in the data and make more confident trades.
What Are the Differences Between Trading and Investing Around CPI and Other Economic Indicators?
One difference is that CPI is a measure of inflation, which can indicate changes in interest rates, currency values, and economic growth, while other economic indicators such as GDP, Employment Rate, Retail Sales, etc. provide a broader picture of the economy and can be used to identify trends in different sectors of the economy.
Another difference is that CPI is a lagging indicator, meaning that it reflects economic conditions that have already occurred. Other economic indicators such as Purchasing Managers’ Index (PMI) can be leading indicators, which can give investors an early indication of future economic trends.
What Are the Advantages and Disadvantages of Trading and Investing Around CPI?
- Provides insight into the overall health of the economy
- Identifying potential investment opportunities
- Helps to make more informed financial decisions
- Can be used to hedge against inflation
- Identifying trends in consumer spending and production
- CPI is a lagging indicator, reflecting economic conditions that have already occurred
- It may not provide a complete picture of the economy
- Inaccurate data can lead to mistaken investment decisions
- It may not be considered as important as other economic indicators.
What Strategies Can Investors Use to Minimize Risk when Trading and Investing Around CPI?
- Diversifying portfolio
- Hedging through inflation swaps
- Using stop-loss orders
- Conducting thorough research and analysis
- Implementing risk management techniques such as value at risk (VaR) analysis
What Are the Different Types of CPI, and How Do They Impact Investment Strategies?
There are several different types of Consumer Price Index (CPI), including the headline CPI, which measures the change in the price of a basket of goods and services consumed by households, and the core CPI, which excludes food and energy prices.
Also, there are also regional CPI, which measures inflation in specific geographic regions, and sector-specific CPI, which measures inflation in specific industries. Each type of CPI can impact investment strategies differently, for example, a rise in energy prices may affect energy companies differently than a rise in food prices will affect food companies.
How Can Investors Use Fundamental Analysis to Benefit from CPI Movements?
Investors can use fundamental analysis to benefit from CPI movements by examining the underlying factors that influence inflation, such as economic growth, interest rates, and government policies. They can also analyze the financial health of companies and industries to identify those that may be more resilient to inflationary pressures and have pricing power, or the ability to pass on increased costs to consumers. For example, companies with huge debt will likely suffer when CPI consistently increases.
What Are the Tax Considerations When Trading and Investing Around CPI?
When trading and investing around CPI, investors should be aware of the tax implications of their investment decisions. Capital gains tax may apply when selling investments that have increased in value, and the tax rate may be higher for short-term gains than for long-term gains.
Dividend income may also be subject to taxes and interest income from bonds. Additionally, some investments such as commodities and real estate may also be subject to other taxes such as sales tax and property tax.
How Can Investors Use CPI to Hedge Against Risk?
One of the most common ways for investors to hedge risk using CPI is by investing in assets that have a strong correlation to the Consumer Price Index (CPI). For example, investors might purchase inflation-protected bonds, which have a fixed rate of return adjusted for inflation, or invest in real estate, commodities, or stocks of companies expected to benefit from rising prices.
They can also use inflation swaps, which are derivatives that allow investors to exchange a fixed rate of return for a floating rate tied to the rate of inflation.
What Are the Different Types of Strategies Used to Trade and Invest Around CPI?
Strategies used to trade and invest around Consumer Price Index (CPI) include:
- Investing in inflation-linked bonds
- Investing in commodities and real estate
- Adjusting portfolio allocations
- Hedging through inflation swaps
How Can Investors Use Derivatives to Capitalize on CPI Movements?
Investors can use derivatives such as futures, options, and swaps to capitalize on CPI movements. For example, they can use futures contracts to speculate on the future direction of inflation or use options contracts to hedge against inflation risk. Also, they can use inflation swaps, which allow investors to exchange a fixed rate of return for a floating rate tied to the rate of inflation, to hedge against inflation risk.
CPI trading strategy backtest – does it work?
We downloaded data from the FRED (Federal Reserve Economic Data) database based on the calendar from the US Bureau of Labor Statistics (BLS). The database has the release dates back to 1949, but we only used the data from 1993.
We converted the dates to Datenum() for both Amibroker and Tradestation/EasyLanguage (both platforms use the same code for date). If you want the code, you can become a Silver member. We have a lot of ideas and code in that membership. For a complete list of what we offer in this package, please click on the link below:
We trust the database is accurate and correct, and all backtests below are based on that database (obviously).
Below we ran some backtests for S&P 500 (SPY), Treasury Bonds (TLT), and gold (GLD):
CPI trading strategy #1 – trading rules (the day of the release)
The first backtest of today buys the open on the day of the CPI report and sells at the close. This is how this would have performed for SPY:
As you can see, the performance is pretty flat: 0.01% per trade, which is more or less the same as any random day.
We see the same pattern for TLT (0.02% gains):
We don’t upload the chart for GLD, but it’s exactly the same: more or less flat.
CPI trading strategy #2 – trading rules (the days after the release)
Let’s change the trading rules and buy at the close of the CPI day and hold for N days. We get the following result for SPY:
The first column shows the result for each holding period. For example, the row holding for 3 days shows the best results of 0.13% average gain. However, this is more or less the same gain as for any random day.
We backtested TLT and GLD using the same rules, but we failed to get much better returns than average.
CPI trading strategy #3 – trading rules (the days after the release)
We also backtested the days leading up to the release. Again, the returns are in line with any random day.