These Geopolitical Risks Influence the Forex Market
Besides regular economic news and macroeconomics, there are other things to consider when trading the Forex market and other markets in general. Geopolitical risks must be considered, as risk-off situations arise when they materialise. The previous two articles here on the Forex Trading Academy dealt with defining the risk-off environment, and what macroeconomics is. There are also other articles referring to fundamental analysis and the economic news that is released on a constant basis. However, the whole picture is not complete if traders are not constantly considering the geopolitical risks. These can come from any part of the world, and the Forex market is the first one to react.
Defining Geopolitical Risks
What are the risks that fall into this category? Can they be avoided? These are two typical questions Forex traders ask when it comes to knowing the geopolitical risks that may arise and how to position for them.
General elections are a good example of a geopolitical risk that can influence the way the market is moving. When elections are due, every 4 or 5 years, traders try to have an idea of what the outcome will be for that respective currency. The more important the country the election is in, the more important the effect on the currency markets will be. The US presidential election is a good example, as we can say with certainty that markets consolidated all year until the outcome was known. In any election, there are two or more candidates. Some are perceived as being riskier than the others, and market participants adjust portfolios and exposure considering the economic policies of those respective candidates.
A referendum is basically the voice of the people when they decide on a specific thing. This can be anything related to the way a country/region is being ruled. Recent referendums that spooked markets were the Greek one when Tsipras, the prime minister, called for the people to decide whether or not to accept the European conditions imposed on Greece, and the Brexit vote in the UK. Both brought a lot of uncertainty to the marketplace, and the volatility index rose to an extreme extent. The UK decision to leave the European Union was a true surprise, as no market poll before the actual vote had suggested that this had any chance of coming to fruition. Yet, it did, and the Forex market acted accordingly: Violent moves were seen on the whole dashboard, not only on the GBP pairs.
The big problem with elections and referendums is the fact that the results are announced over the weekend most of the time. This guarantees a gap at Monday’s opening, and this gap is difficult to predict. Not only is it difficult to predict, but going over the weekend with open positions is not recommended. This is because the Forex brokers do not guarantee a fill unless there is a market at a specific level. Long story short, if the market opens with a gap above/below the stop loss order, the broker will execute the order on the market when there is a market, and not at the pre-set level. This is a big problem for Forex trading, and made people wonder what the best money-management approach is. It goes without saying that the best approach is to avoid trading these events and close the positions before the weekend starts, namely before Friday’s closing. While this is the thing to do, it is rarely that traders follow this simple money-management rule. The thing is that trading is a contrarian thing, and people are always trying to pick a top in a bullish market, or a bottom in a bearish one. After all, what is technical analysis if not the ability to pick tops or bottoms? This is a costly process though, and not everyone is suited to it. Nevertheless, it’s human nature that is responsible for traders acting the way they do.
War belongs in the “unforeseen events” category, and every time there is a conflict on the horizon, markets are the first to react, and violently so. There is no need for an actual reason for the market to move, as the mere ignition of such an event is enough. Two examples come to mind that are pretty much relevant to the topic. One is related to the Iraq war, when the United States and the coalition members invaded Iraq. Before the event, the overall market was in a limbo in the sense that it anticipated the war but didn’t really expect to see it breaking out. The final meeting took place between the secretary generals of the two parties involved, and a press conference was awaited. By the time the press conference started and it was obvious the operation was going to get a green light, the USD had already travelled some distance. In such situations, market participants are looking for safety in safe-haven assets, and the US dollar is such an asset.
Another recent event that belongs to the same category happened when Russia invaded Crimea and took the region from Ukraine. Markets were taken by surprise, as was everyone else, and uncertainty surrounded the event. Geopolitical risks are everywhere, and one can only adapt to the ongoing situation. By the time a conflict/situation is ending, another one in another part of the world is starting. The idea behind this is to constantly stay informed and up to date regarding what is happening on the international scene, and how the Forex market may react to these events. One can never be fully prepared, and cutting losses or letting the profits run is the thing to do under such conditions.
Another brewing conflict these days is starting in the South China Sea, as many countries in that area are claiming the rights over some islands. While China is taking them over as we speak, others are manifesting their discontent, and the conflict has the potential to escalate. The JPY and other Asian currencies may be affected by this situation, so traders involved in those markets should be aware that this is a risk that might affect their trades. Money management and the way to approach such a situation is key again. To sum up, geopolitical risks are everywhere, and they can appear out of nowhere. The Forex market is usually the first one to react to such risks, so the more we, as traders, know, the better.
Other educational materials
- Risk-off vs. Risk-on Trading
- Macroeconomics in Forex Trading
- Composite Index
- Toronto Stock Exchange (TSX)
- Different Trading Styles
- Profit from Forex Trading Using Different Trading Styles
- How to Set Up an Expert Advisor
Recommended further readings
- “A very North Atlantic credit crunch: geopolitical implications of the global liquidity crisis.” Nesvetailova, Anastasia, and Ronen Palan. Journal of International Affairs (2008): 165-185.
- “Understanding the geopolitical implications of the global financial crisis.” Xinbo, Wu. The Washington Quarterly 33, no. 4 (2010): 155-163.