7 Things to Know About Financial Indicators

• Financial indicators are a group of companies whose shares are traded publicly on specific exchanges, and the job of an indicator is to calculate the overall performance of the market based on the companies it contains.
• The data behind these financial indicators is published regularly, since financial indicators are one of the precise measures used to assess the market and the strength of the economy.
• Experienced traders base their buy or sell decisions on different trading strategies, and most of these strategies rely on information or data obtained from multiple financial indicators.
• Most trading strategies are not only about increasing the return from trading, but also depend on how the risk-to-reward ratio is managed.

There Are Two Types of Financial Indicators:

• General financial indicators: these are indicators used to measure the state of the market in general. Examples include:
• S&P 500 Index (DJIA (S&P500))
• Dow Jones Industrial Average Index
• Sector financial indicators: these indicators are used to measure the state of the market for a specific category of industries or a specific sector. Examples include:
• S&P 500 Index (DJIA (S&P500)) for an industry such as the utilities sector.
• Dow Jones Index for an industry such as the transportation sector.

The Importance of Financial Indicators and Their Relationship to Economic Conditions

• The financial indicator used to measure the state of the market as a whole is a mirror of the country’s economic condition, since a large part of a country’s economic activity is represented by the entities whose securities are traded.
• The future economic condition can be predicted, and this can happen before any change occurs, ahead of a period of time, as securities markets carry certain characteristics.
• When the expected movement of stock prices points upward, this state is called a bull market (Bull Market), and in this case the return on a risk-free investment, known as a riskless security, is lower than the rate of return the market achieves according to the index.
• When the index moves in a downward direction, the market in this case is called a bear market, and in this case the return on a risk-free investment (riskless security) is higher than the rate of return the market achieves according to the index.
• This means that, through financial indicators, the relationship between (the rate of return the market achieves according to the index) and (the return on a risk-free investment) is an inverse relationship depending on the state of the market (bullish or bearish).
• Speculators in financial markets are classified on this basis, meaning that when a speculator believes the market will take an upward curve, the speculator is described in this case as bullish.
• When a speculator believes the market will take a downward curve, the speculator is described in this case as bearish.

Uses of Financial Indicators

There are many uses for financial indicators that concern traders, investors, and everyone dealing in the financial markets. These uses include: See also our guide to Technical Indicators.

• Showing portfolio performance, since speculators can compare the change that occurred in financial indicators, whether positive or negative, allowing the investor to quickly form an idea about portfolio performance.

A market index reflects a well-diversified portfolio without the need to track the performance of each security individually, and if an investor’s investments are in a specific industry that has its own index, it is better for them to follow that specific index.

• Another use of financial indicators is evaluating the performance of professional managers, since an investor can obtain a return equal to the return reflected by the financial index for market returns by holding a randomly selected portfolio of securities.

This means that a professional manager’s use of advanced diversification methods is expected to achieve a higher return than the market return, in line with the principle of Naive Diversification.

• Predicting the future state of the market: a financial analyst can predict the future state of the market if able to perform a fundamental financial analysis, which is understanding the relationship between economic variables and changes in the indicators.

An analyst can also predict future developments in the direction of price movement in the markets through technical or historical analysis of the indicators that reflect market conditions, through which patterns in market changes can be identified.

• Predicting and estimating portfolio risk, since financial indicators allow us to measure the systematic risk of a financial portfolio, which is the relationship between the rate of return on risky assets and the rate of return on the market portfolio made up of risky assets.

Building Financial Indicators

Methods for calculating and building financial indicators vary, but they are all built on three foundations: the selected sample, the relative weight of each stock within that sample, and the basic method used to calculate the index value.

The Selected Sample and Its Suitability

This is the group of securities used to calculate this index, and it must be suitable in terms of:

Source, breadth, and size

Regarding size, the rule is that the more securities included in the index, the more representative the index becomes.

Regarding breadth, this means that the selected sample must cover the various sectors participating in the securities market, and the index measuring the state of the market must include shares of establishments in every sector making up the national economy.

Regarding source, this refers to knowing the stock prices on which the index is based, and the source must be the primary market in which the securities are traded.

How to Calculate Relative Weights

The relative weights used in building indicators represent the relative value of a single stock within the sample, and there are three common approaches for determining a stock’s relative weight within the group of stocks the index is built on:

1- Price Weighting: this means the ratio of a single company’s stock price to the total prices of the other individual stocks that make up the index.

One drawback of this approach is that the relative weight is based on the stock price alone, while the stock price may not reflect the importance or size of the company.

2- Equal Weighting: this means assigning an equal relative value to every stock within the financial index.

• Value Weighting: this means giving a stock a weight based on its total market value for the number of common shares of each company represented in the index, and this overcomes the main drawback found in the price-based approach.

Here, the stock price is no longer the sole determinant of relative weight, since companies with an equal market value for their common shares carry an equal relative weight within the index regardless of the number of shares or their price, meaning no distortion occurs in the resulting financial index.

Examples of Global Stock Exchange Indices

• United States: Dow Jones Index – S&P 500 Index – NYSE stocks – S&P 100
• England: FT-30 Index – FTSE 100
• France: CAC40 Index
• Germany: DAX 7030 Index

Examples of Emerging Markets

• Thailand: SET Index
• Taiwan: TSE Index
• Singapore: OCBC Index

Examples of Arab Indices

• Egypt: CMA
• UAE: NBAD
• Saudi Arabia: NCFEI
• Morocco: MASI

From the above, financial indicators can be described as the activity concerned with converting financial data, information, and the financial ratios recorded in financial statements into information with specific meanings.

Sound financial management is also critical, since it allows you to make informed decisions in a timely manner in response to changing conditions, and this is done through financial indicators.

What is surprising is that many entrepreneurs only look at financial indicators at the end of the year, or even a few months later, once the financial data becomes available, and this lack of attention puts their business at risk.

Read more:

• How to Learn the Stock Market for Beginners
• How to Invest in the Egyptian Stock Exchange Step by Step
• How to Profit in the Egyptian Stock Exchange?

FAQs:

What are the types of financial ratios?

The common financial ratios every company should track are: 1) liquidity ratios, 2) leverage ratios, 3) efficiency ratio, 4) profitability ratios, and 5) market value ratios.

What are the standards of financial analysis?

A financial analyst carefully examines a company’s financial data, the income statement, the balance sheet, and the cash flow statement.

How do you read financial ratios?

If a company has $200,000 in debt and $100,000 in equity, the debt-to-equity ratio is two ($200,000 / $100,000 = 2). This means the company has one dollar of equity for every two dollars of debt.

What are financial indicators?

There are six basic ratios most often used to select stocks for investment portfolios. These include the working capital ratio, the quick ratio, earnings per share (EPS), the price-to-earnings ratio (P/E), the debt-to-equity ratio, and return on equity (ROE).

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