What is an Economic Indicator?

An economic indicator is an index or other data that suggests whether the economy is expanding or contracting.

How Does an Economic Indicator Work?

For example, the U.S. Department of Commerce reports the amount of new factory orders every month. The information is divided into four parts: new orders, unfilled orders, shipments, and inventories.

The report includes information about durable goods and nondurable goods. Factory order data is often not very surprising, if only because the report of durable goods orders comes out one or two weeks earlier.

When factory orders increase, the economy is usually expanding as consumers demand more goods and services (which in turn require retailers and suppliers to order more goods from factories). Note that increases in factory orders could also mean that inflation may be just around the corner. When factory orders decrease, the economy is usually contracting -- there is less demand for goods and services and thus less need to reorder supplies. Thus, the factory orders report is an economic indicator.

Why Does an Economic Indicator Matter?

Economic indicators can help investors decide where to put their money. For example, as the economy slows, countercyclical companies grow. Investors attracted to stocks in countercyclical industries are faced with the arduous task of trying to time the market -- that is, to predict the bottom of the business cycle to sell at the optimal time and then predict the top of the cycle to buy at the optimal time. This can be hard, given the fact that some countercyclical stocks start sliding before a recovery has actually begun, but economic indicators can point to where the economy is headed, making the decision easier.