The foreign exchange market was, is, and will likely continue to be the world’s biggest and most liquid financial market. Approximately, about 6.6 trillion dollars is traded in the forex market daily and about 250 billion dollars an hour. It is the most lucrative platform where banks, world economies, financial institutions, businesses, and individuals trade currencies.
The value of a currency is affected by other currencies, especially the US Dollar. About 60% of all daily global currency transactions hang around the US dollar, making it the most traded of all currencies in the world.
Everyone at one point in time trades in the foreign exchange market either directly or indirectly. This article delves into the impact of Geopolitical Events on the forex market so that traders can be adequately informed in their decisions.
Factors Affecting The Forex Market
Several events across the globe can influence exchange rates and value of currencies. The global interconnectedness of the forex marketplace is responsible for this phenomenon. Some of these influencers include but not limited to Geopolitical events, Interest rates of central banks, Inflation levels, Unemployment rates, Oil prices, Global growth rates, Currency devaluation, elections, political unrest, etc.
All these factors affect the currency market in many ways. A classic example is the unemployment rate. Higher unemployment rates above the normal threshold signal economic distress and instability thereby reducing consumer spending. These issues can lead to weaker currencies since investors shy away.
Geopolitical Factors, what are they?
The purpose of this article is to delve into the various geopolitical factors that affect the forex market, how they affect the forex market, and how to profit from them and avoid losses.
The Merriam-Webster‘s dictionary defines geopolitics as: “a study of the influence of such factors as geography, economics, and demography on the politics and especially the foreign policy of a state, a combination of political and geographic factors relating to something”
The word geopolitical describes politics and policies that concern a particular country, region, or territory. These events are known to influence the currency exchange rates of countries and geographical locations. A few of these geopolitical events include Political unrest, Civil wars, Mutinies, Threats against countries, Warfare, Changes in political regimes, etc.
The Impact of Geopolitical Events on Forex Markets
These geopolitical events have the capacity to impact forex markets in the short or long term or both. These geopolitical events usually affect the country that it is happening in and the entire world at large. Here are some of the ways geopolitical events can affect forex markets:
Elections
The period before and after elections has grave effects on macroeconomic stability. Especially the period before elections fosters economic uncertainties among local and foreign investors. The outcome of an election could either boost or destroy the economies of countries. For instance, the election of French President Emmanuel Macron in 2017 was already expected due to the earlier polls in his favor. His official win in May 7, 2017 did not only affect the French positively but the entire European market was affected. This was seen surge in the Euro against other currencies, especially the US Dollar. The Euro dipped after the US election in November 2016 but the election of President Macron caused the Euro to climb to its highest price in half a year and broke above $1.10 for the first time since the US elections in 2016.
Changes in Political Stability
Political instability is a determinant factor in the value of currencies across the globe. Throughout world history, countries experiencing political suffer several issues together with the devaluation of their currencies. The effects of these instabilities are enormous but one key result is the shying away of investors and the closing down of most enterprises that foster the growth of economies. Coup d’etat especially, have devastated major economies across the world and Africa. The World Wars are another major example of instabilities that affected the economy of the world.
Shifts in Trade Policies
Geopolitical events had led to changes in trade policies which significantly impacted foreign exchanges. Conflict between countries arouses the imposition of tariffs affecting the demand for currencies, and the supply chain of companies which eventually affects the value of their respective currencies.
The geopolitical tensions have greatly impacted the world since the twenty-eighteens. Friend-shoring, or trade between geopolitically aligned countries, has increased, while trade between rivals has decreased. This significant change reveals that global trade is now influenced by more than just profit motives – geopolitical alignment is a major factor. The US-China tariff war and the invasion of Ukraine by Russia have increased the trade restrictions across the world divide.
Changes in Interest Rates
Central bank monetary policies are informed by Geopolitical events leading to changes in interest rates. These interest rates determine currency valuations and the forex markets. The increment of interest rates by central banks births an increased demand for that country’s currency because investor’s returns also increase. On the other hand, when central banks decrease their interest rates, the demand for that currency drops.
Geopolitical Events That Affected The Forex Market In Recent History
Brexit and the British pound
The British Pound fell to its lowest value against the US Dollar after Brexit. This was all over the headlines in the newspapers across the media. The United Kingdom’s resolution to leave the European Union was a geopolitical event that greatly affected the pound sterling exchange rate fueled by the pulling out of investors due to uncertainties about the future of the British economy after Brexit.
Fukushima disaster
The 2011 Fukushima disaster, the worst nuclear accident since 1986 in history after the Chernobyl disaster affected the whole world not just Japan where it happened. This event has drastically and fatally shifted the Japanese exchange rate such that till today, investors are afraid of investing in the Japanese economy. There is the fear of any probable natural disaster in this fashion in the future.
Covid-19
COVID-19, the pandemic has not only influenced the foreign exchange market and the world’s economy but all aspects of the world. The pandemic has fueled significant changes in the US dollar exchange rate, lowering of oil prices, and general high volatility in the Forex market. This fueled instability in the various economies provoking the sale of assets by many investors whilst some made significant gains, others also lost drastically
China-Taiwan conflict
The escalation of the enduring conflict between Taiwan and China happened somewhere in the second quarter of 2023. The Chinese government has decided to conduct military drills in the waters of the island of Taiwan in the name of Chinese sovereignty. The Taiwan government seeking to gain independence from the Chinese government due to the drilling of the waters of the island of Taiwan in the name of Chinese sovereignty sparked a counterattack from the Chinese government. The Forex investors have monitored the situation leading to the demand for the Japanese yen as a haven instead of the Chinese yuan and Taiwanese Dollar. Of course, the strength of the Japanese yen would rise whilst the Chinese yuan and the Taiwanese Dollar would fall.
And the forex traders who implemented fundamental analysis in the strategy and have foreseen the influence this geopolitical event would have profited significantly.
Russian Invasion of Ukraine
On February 24, 2022, Russia invaded Ukraine, sparking one of the biggest wars since World War 2. The Russian ruble and Ukrainian hryvnia collapsed, while crude oil prices soared. The US dollar rallied as a safe-haven currency on the Forex market, outperforming European currencies. Surprisingly, the Swiss franc and Japanese yen also weakened. Stock markets reacted as expected – the FTSE 100 collapsed, and the S&P 500 declined after trying to hold its ground.
Managing the Risks of Geopolitical Events
Seeing how profitable these Geopolitical events can be amongst some traders, a greater number suffer significant and unprecedented losses due to increased market volatility during these periods. Most traders end up blowing their accounts. This can be very challenging for forex traders. The following are some proving steps and strategies to help avoid losses and increase profitability amidst geopolitical events:
Endeavor to Be Current
Imagine what ignorance of an ongoing geopolitical event would do to a forex trader who invests heavily in an economy that is on the verge of falling. Forex traders need to stay up to date with geopolitical events that can impact currency valuations. They can do this by regularly monitoring news outlets, economic reports, and political events. Staying informed helps traders make informed trading decisions and mitigate the risks associated with forex trading. Traders can use apps that constantly provide forex and economic news.
Diversification and Hedging
To guard against the negative effects of geopolitical events, it is necessary to diversify your investments. Diversification can be achieved by investing in various currency pairs to avoid risking all your capital in one trade. Since it is impossible for all industries or economies to be concurrently hit, diversification is the key to avoiding the blowing of accounts. Forex hedging is a strategy aimed at reducing potential losses from undesirable exchange rate fluctuations by fixing the value of the acquired currency. When hedging, the investor transfers their risks to the market. This risk management tool allows you to open additional positions to protect yourself.
Proper Risk management
Every successful forex trader has a well-drafted and followed risk management strategy. Proper risk management shields traders from the effect of geopolitical events that may go against their trading plan. A risk management strategy includes a profit and stop-loss plan also known as risk to reward ratio strategy, Break even strategy, etc. With all these strategies in place, irrespective of what happens in the market, you will save your capital.
