Sep 4, 20205 min read

How to Pick Trades with the ISM PMI Report

What is the ISM Report?

It’s a collective name for two monthly reports. These being the Manufacturing ISM Report on Business (PMI) and the Non-manufacturing ISM report on business (Services PMI). These are released by the Institute of Supply Management hence the “ISM”.

The ISM report is basically a massive survey of purchasing managers. What does it do? It tracks how well the manufacturing and services industry is doing. Based on these two sectors it’s now known as one of the most reliable economic indicators of the U.S. economy by giving an early indication of what’s going on and how businesses, consumers and governments can prepare themselves.

How do they get the data? The ISM asks purchasing managers of over 300 manufacturers for their outlooks on the economy, business and basically what they think will happen in the future. This data is then compiled together and released on the first business day of the month which makes it a really useful early indicator for investors and policymakers. The services PMI is released a few days after, so you’ll find the ISM reports together are released in the first week of each new month.

It’s useful because if you monitor the ISM PMI and Services PMI you have a gauge on the economic trends and future conditions. For example, generally when the index is rising investors will expect a bullish stock market so will seek to take long trades.

The ISM PMI is actually a composite index which is a combination of:

New orders
Production
Employment
Supplier deliveries
Inventories

Each being equally weighted in the equation.

How do we analyse the ISM Report?

The report has a few things we’re interested in. This includes the % value you see for the PMI itself which signals whether the sectors are contracting or expanding (growing or shrinking). Then there’s the qualitative comments and notes mentioned by the respondents and managers.

Here we can get a gauge on how we should be trading based on future expectations. For example, you wouldn’t really want to be buying U.S. airlines when the purchasing manager mentions that the airline industry is under great pressure. If they’re not making money then the stocks are likely to go down, so you have a good idea to avoid buying it and actually maybe sell it!

If you’re trading currencies on the other hand the actual value is what you want to keep an eye on. The main reason being when the value is above 50 and growing this is expansionary for the economy and when it’s below 50 and falling this is a contraction. This means when the value is above 50 we actually have a inflationary outlook which means the currency value is likely to decrease and when it’s below 50 it’s likely to increase.

You can see on the PMI chart that when it falls below 50 and continues to fall we actually have recessions. This is seen in the 2000s, 2008 and very recently in 2020 from COVID-19.

When we put GDP annual growth rates and the ISM PMI data side by side we can clearly see that with a high accuracy the ISM PMI predicts future growth. So when the ISM PMI starts growing, GDP growth is likely to follow in the future and when the ISM PMI is falling GDP will likely follow in the future too. If you’re not using it in your analysis you need to be!

The ISM PMI predicted the last 3 recessions.

What about stocks? How can we pick trading stocks using the ISM PMI? Well, there’s some key points we need to take from the ISM PMI.

These include:

ISM PMI > 50 = bullish stocks
ISM PMI < 50 = bearish stocks
We also need to use the qualitative notes from the ISM report to identify which sectors are growing and which are contracting.
Once identified we want to be buying the growing sectors and ideally selling the contracting sectors.

Here’s some information from the ISM report. We can see out of the 18 manufacturing industries 15 showed growth and 3 showed contractions. This gives us a good idea on which stocks to be buying that month and which to sell to hedge our risk. E.g. in the above example we want to be selling “Printing & related support activities, Petroleum & Coal products and furniture related products” then buying the 15. We do the exact same analysis with the services PMI to trade those stocks.

What about the USD/RUB Idea?

If you've been reading out trade ideas then you'll realise we have a potential forecast of a USDRUB short. The ISM PMI report has been growing at an insane rate, with the PMI sitting at 57% this is inflationary for the USD. This means we'd have a short conviction and that the ISM PMI agrees with our idea too.

This means most other USD pairs may see a potential downside but we'd have to also see what other fundamental factors are saying.

Doing a more detailed look into ISM PMI and USDRUB we can take away a few key things that will improve our outlook on how to trade using fundamentals. For example, during 01/10/2015 we saw USDRUB hit all time highs this was in combination with the ISM PMI falling below 50 for the first time in over 2 years. What we saw in the next few months is the ISM PMI grew above 50 and continued to grow over the next 2 years.

What happened in that same period for USDRUB? We saw USDRUB fall in value as this is inflationary on the USD meaning there's more supply of the dollar around which means the price of the dollar falls!

The exact same thing has occurred now in 2020 where the ISM report dips below 50, USDRUB hit all time highs and we're now potentially seeing the top of USDRUB. I have my eyes set on this one on my watch list with high hopes over the next few months.

Just make sure to use the volatility calculator when setting stops and targets, it's probably not one we can scale into due to the nature of the pair but a 1:3 risk reward is achievable here

ISM PMI vs U.S. Stock Market

The ISM PMI is a really important tool not only in forex trading but for trading stocks too. As I mentioned earlier when the PMI growing we should be bullish of the stock market and when it's falling we should be bearish. You can see the data during 2015 where the ISM PMI dipped below 50 we saw a pullback on the stock market. The same again at the start of 2020, purchasing managers didn't have a great outlook of 2020 and they were right. COVID-19 had a devastating impact which saw the U.S. Stock market S&P 500 drop over 15%.

Now that the ISM PMI is quite bullish of future outlooks the stock market had a huge rally.

Hopefully now you've got a nice idea of how to include the ISM PMI in your trading.

This is just one of the variables we include in our Macro Currency Strength Meter when analysing economies. If you want a broad view of the economy, currency value and stock performance you might find our free web class quite useful here's the link.

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