The Impact of Geopolitical Events on Forex Markets

The foreign exchange market trades on the relative strength between two separate currencies, and swings in prices reflect the realities of geopolitics – sometimes in the most exaggerated way.

Geopolitics is a form of global geographic analysis of power and politics. Understanding it is also critical to understanding its impact on currency correlations and volatility.

Unexpected Elections

Geopolitics is the science of understanding geography through politics and power, and it is a colossal driver of forex movements. Political events on the global stage, such as elections or changes in governments, can dramatically shift demand for a certain currency, thus affecting an exchange rate.

It is often quite difficult to understand how global events can impact forex trading, but traders should always be aware of how political developments are going to impact the markets around the world. The recent elections in Mexico, South Africa and India caused unforeseen fluctuations in the global markets and currencies. Political instability and the uncertainty about the future economic situation can cause a lack of confidence in the country’s currency, which can badly affect its value. If investors are moving their investments out of a currency that is affected by a political issue and into traditional asset markets, it is important that traders keep tabs on the political events as an important factor in their trading strategy. They should diversify their portfolios with the help of technical analysis strategies and also fix stop loss orders as fast as possible if they think that any political unrest has started.

War

The forex (foreign exchange) market is the largest and most continuously active financial market in the world. Daily trading volumes in the forex exceed trillions. The ripples on this pond can be so tremendous in reaction to current events around the world (or even so prosaic as the weather gleaned from weather satellites that assess cloud cover), that they frequently swamp macroeconomic considerations – and have deeper effects that last longer than macroeconomic trends.

The recent hostilities between Israel and Palestine have had various impacts in forex markets. Oil prices have gone up, leading commodity-based countries like Israel (Shekel) in negative news. Its value also dips against the US Dollar.
But with sound research and proper strategy traders can leverage the instability of the market into big profits; several traders have reaped huge profits by trading politics on forex. By understanding the market drivers, macro and micro events, these traders take advantage of the movement beforehand by averting it, and after by trading when it happens.

Terrorism

Terrorist attacks might also cause forex markets to move in the opposite direction to equities: a significant terrorist incident in one country is likely to result in a precipitous loss of faith among investors in that country’s prospects, who will shift towards cash or into other so-called ‘safe haven’ currencies such as the yen or Swiss franc. Any of these movements could potentially result in the devaluation of a given country’s currency against others in the medium to long term.

But the terror premium is short-lived and will subside over time, taking note of the above forex pairs, which trade against the euro, among others.

Our empirical results provide evidence that euro pairs that involve the currency of victims of terrorist attacks generate significant negative abnormal returns on the day of an attack and in event windows of 5, 10 and 15 days post-attack, which implies that market participants are getting less and less willing to punish terrorist attacks.

International Agreements

Since forex markets are global markets, an event anywhere in the world has the potential to change trading activity and affect all currency trading. Changes in market sentiment across global markets create volatility, and the role of a forex trader is to identify opportunities created by volatility to formulate a trading strategy with a positive edge over trading losses.

Traders must also watch carefully for political and economic policy changes. Monetary indicators, such as changes to interest rates or easing measures, might affect specific currency values, while fiscal indicators, including tax levels or government spending, might influence them further.

A significant part of geopolitics is changing international trade agreements, and FX prices will respond to this immediately. The US-China trade war is a good current example that can provide more opportunities for traders to make quick money, like buying USD and selling Yuan pairs together. Keeping abreast of such trade sanctions will assist traders with risk management to ensure that suitable decisions are made; otherwise, they are conducting business with banned countries.