Trader’s guide to the Purchasing Managers’ Index

Graph showing a slow uptrend
By :  ,  Financial Writer

In the world of finance and economics, reliable indicators are invaluable for assessing the health of industries and making informed trading decisions. One popular indicator is the Purchasing Managers’ Index (PMI). The PMI serves as a reliable gauge of economic activity and sentiment within specific sectors. In this article, we’ll cover what the Purchasing Managers’ Index is, how it works and how you can use it in your trading strategy.

What is the PMI?

The Purchasing Managers’ Index (PMI) is an economic indicator that provides insight into the manufacturing or services sector's overall health within a particular country or region. It measures whether economic conditions are growing, shrinking or staying the same. Economists consider the PMI when judging the overall health of a country.

It is designed to reflect changes in production levels, new orders, employment, supplier deliveries, and inventories. The PMI is typically represented as a single numerical value, usually ranging from 0 to 100, with a reading above 50 indicating expansion and a reading below 50 indicating contraction.

The PMI calculation can be used for other industries, but the manufacturing sector receives more attention than other PMI calculations. The manufacturing sector is no longer as influential as it was when the PMI was first used in 1948. However, the sector still represents a large portion of the domestic economy.

How is the PMI calculated?

The PMI is calculated by surveying purchasing managers at hundreds of major private sector companies. These executives are surveyed on five key business elements: production levels, new orders, employment, supplier deliveries, and inventories. Respondents are typically asked to rate these factors as either positive, negative, or unchanged compared to the previous period.

PMI surveys were first conducted by the Institute for Supply Management in the US starting in 1948. Since then, it’s become a popular survey in dozens of countries worldwide. In Singapore, the Singapore Institute of Purchasing and Materials Management produces their monthly PMI, and the S&P Global produces PMI reports for over thirty other countries including Australia, Canada, Japan and the UK.

Once the survey responses are collected, each component is assigned a weight based on its significance in the sector's overall performance. The weighted percentage of positive, neutral and negative responses are tallied using a simple formula to derive the PMI.

A PMI rate above 50 represents positive economic growth, and a measurement below 50 indicates conditions are worsening. The further the PMI is from 50, the more change is indicated for the previous month.

PMI formula

Learn how to calculate PMI using this simple formula. PMI rates are calculated monthly before publication, so you'll never need to calculate them yourself, but it can be useful to understand the basics.

PMI = (P1 x 1) + (P2 x 0.5) + (P3 x 0)

  • P1 = percentage of improvements reported
  • P2 = percentage of no change reported
  • P3 = percentage of deteriorations reported

How the PMI works

The PMI is based on the concept that purchasing managers, who are responsible for procurement and supply chain management, have valuable insights into the current state of their respective industries. As the PMI focuses on forward-looking factors, such as new orders and production levels, it is considered a leading indicator, providing a glimpse into future economic trends.

The PMI's components reflect the dynamics of the sector being measured. For example, a rise in the new orders component indicates growing demand, which can lead to increased production and potentially higher revenues for companies in the sector. Similarly, changes in employment levels and supplier deliveries shed light on business sentiment and supply chain disruptions, respectively.

The PMI is released on a monthly basis, providing timely updates on the sector's performance. It is commonly tracked by economists, investors, and traders to gauge economic conditions and make informed decisions.

What the PMI means for traders

Traders often utilise the PMI as a leading indicator, as it provides valuable insights into the market sentiment and the direction of the economy. Traders can utilise the PMI for:

  1. Identifying economic trends: By monitoring the PMI over time, traders can identify trends in economic activity. A consistent upward trend in the PMI suggests a growing economy, which may present opportunities to invest in sectors experiencing expansion
  2. Performing sector analysis: The PMI is often broken down into sub-indices for specific sectors, such as manufacturing, services or construction. Traders can analyse these sub-indices to identify sectors that are outperforming or underperforming and adjust their strategy accordingly
  3. Finding correlations with other indicators: Traders can examine the PMI in conjunction with other economic indicators such as GDP growth, consumer confidence or industrial production to gain a more comprehensive view of the economy. Correlations and divergences between these indicators can provide valuable trading signals
  4. Assessing the impact on currency markets: The PMI can influence currency markets, as it reflects the overall sentiment and economic conditions of a specific country. A higher PMI reading indicates economic expansion and may lead to increased demand for the country's currency
  5. Predicting market reactions: The release of the PMI data often triggers knee-jerk market reactions, especially in sectors related to the data being reported. Better-than-expected PMI readings may lead to bullish market sentiment, while negative PMI readings may result in bearish sentiment

How to trade using the PMI

Open a City Index account or log in to start using the PMI in your trading strategy. If you’re not ready for live markets, practice trading in a City Index demo account, and read the latest from our team of expert analysts covering PMI reports.

It is important to note that the PMI is based on surveys and subjective opinions of purchasing managers, which is separate from real market conditions. Additionally, the PMI rate provides a snapshot of the present conditions but does not account for other factors such as geopolitical events, policy changes, or technological disruptions. It’s crucial to consider the PMI in conjunction with other indicators and factors to obtain a comprehensive view of the market and manage risks effectively.

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