How Geopolitical Events Can Increase FX Risk
Jul 12, 2022
When you're working with the currency market (Forex), it is likely that you face plenty of risks that can affect your results. Anything from ongoing events down to simple human speculation can affect currency prices so significantly that you may have to change up your strategies to ensure you remain on the road to success.
That being said, one particular type of risk doesn't get as much attention as it deserves despite how important it is. Geopolitical risk is something that's real, and if you truly want to make the most in currency markets, it is something you must consider with great weight.
With that in mind, let's delve deeper into geopolitical risk, talking about everything there is to know about it. But first, let's shed a little more light on the currency market to give you more information on the context of geopolitical risk:
What Is A Currency Market?
Before anything else, it is important to understand what a currency market is.
Simply put, a currency market is the most lucrative and largest market platform in the world. It's the place where banks, financial institutions, businesses and economies of all sizes buy and sell currencies. Participants in these markets tend to be financial institutions, central banks, and large corporations.
When it comes to the biggest currency market, there is no doubt that the U.S. dollar rules the charts. In fact, the U.S. dollar accounts for around 60% of all global currency transactions on a daily basis.
It turns out that most of the world's trade transactions, including approximately 80% of the transactions involving all of the U.S.'s trading partners, are made in U.S. dollars. This might be due to the fact that the U.S. dollar is a stable currency that has been the world's reserve currency for decades.
The U.S. dollar is so important that it is the only currency that is used in the international payment system. This is reflected in the U.S. dollar's reserve currency status. The U.S. dollar is also the most liquid currency in the world. This means that it can be easily converted into reserve currencies.
One more thing about the currency market is that it is one of the most transparent markets in the world. Even though you can't find out about every single transaction that goes down in the currency market, you have plenty of information at your disposal. Most of the world's markets are connected to one another, so you can get the information you need to make better decisions.
What Affects Currency Exchange Rate?
When it comes to the currency market, there are plenty of factors that can affect the exchange rate. Some of these factors are:
Global growth rates
And so much more
Each of these factors can affect the currency exchange rate in different ways. For example, when the unemployment rate is higher than it normally is, the currency exchange rate can fall since foreign investors will no longer be interested in stocks that pay little or nothing.
These factors can also be affected by geopolitical events. If a new body of legislation has been introduced in a particular country that could affect currency exchange rates, there are plenty of ways to deal with these issues.
What Risks Have The Biggest Effect On The Currency Market?
Among the many risks in the forex market today, the biggest currency market risk is geopolitical risk.
Geopolitical risk has the biggest effect on all currency markets, but the risk has a bigger influence in some areas than others. For example, the U.S. dollar is the most affected by geopolitics, while the Japanese yen is the least affected.
However, the impacts are rarely isolated. Currency exchange rates are affected in many ways, and other factors in the currency market can affect currency exchange rates as well.
What Does The Term "Geopolitical" Mean?
The word geopolitical means that it involves politics and policies that are related to a specific part of the world.
More often than not, geopolitical events can take place in countries, regions and territories. These events can affect currency exchange rates, which means that they can affect the currency market in general.
Some of the most common geopolitical events are:
Threats against countries
While these geopolitical events can and will affect the country that it is happening in, they can also affect the entire world, especially when looking at it in terms of the currency market.
How Does Geopolitical Risks Affect The Forex Market?
When it comes to the currency market, geopolitical risks can affect the market in multiple ways.
Geopolitical risks can affect the currency market by leading to new policies or through changes to existing policies. It could also lead to new regulations that can influence the market. On top of that, geopolitical risks can impact the country's economic growth, which affects the economic outlook and changes the outlook on currency exchange rates.
When a country starts to deal with political unrest, civil wars and mutinies, it can put a strain on the country's financial system, which can affect the country's currency exchange rates. This is why in some cases, the government will try to shore up the fiscal situation by increasing taxes and cutting spending.
Other situations that can impact currency exchange rates are those that are tied to the goods and services involved. If a country is affected by a natural disaster, the currency exchange rates may be affected. The same thing is true if a country is affected by an epidemic.
However, it is always important to keep in mind that geopolitical events can also have positive impacts on the currency market. For example, if a country is able to resolve a region's conflict, that can be a positive event for economic growth. This can also be said of a country that is able to stabilise its economy and financial system.
What Political Factors Affect The Forex Market?
When it comes to political factors that affect the currency market, there are plenty of them.
It is important to note that almost all political factors can have great impacts on the currency market. Here is a look at some of the most common ones:
Threats against countries
As you can see, most of the political factors that affect the forex market are related to warfare. This makes sense, considering that war can have a great impact on the economy, even if the two are not related. When we look at the geopolitical events that take place in countries, we can see that warfare is not just the top event, but it is also the most serious of all geopolitical events. One big example of this is the Ukraine-Russian conflict, where the war has caused havoc in many markets such as oil. This, in turn, has affected the FX market drastically.
What Are The Geopolitical Events That Have Occurred And Affected Exchange Rates?
Many geopolitical events have occurred in the past that has severely affected the FX market. Here are a few examples:
The United Kingdom is one of the most significant countries in the world, both politically and economically. This is why when the United Kingdom's economy took a hit in 2007 as a result of the financial crisis, it affected the British pound and the global economy in general. The British pound can be considered as one of the most stable currencies in the world, and the fact that it fell triggered a domino effect that affected the entire forex market.
Spain is another country that has been affected by economic turmoil. The turmoil in Spain was seen in 2011 when its economy fell into recession. This was a result of the financial crisis that started in 2007. This is not a single event, as well. The country has experienced this event a couple of times. When it comes to the domino effect of the Spanish economy, it can be seen in the forex market, especially when it comes to currencies like the New Zealand dollar and the Australian dollar. It's also seen in currencies such as the Japanese yen and the British pound.
The Japanese yen is one of the world's most popular currencies, and its popularity is not limited to Asia. The yen is one of the most traded currencies in the world. The yen is not tied to any country, so it can be traded in almost every country under the sun. However, there are still risks tied to trading the yen currency. One of these risks is related to geopolitics. When it comes to the geopolitics of the yen, there are two events that stand out. The first one is the 2011 Fukushima earthquake and tsunami, which caused the Fukushima Daiichi nuclear disaster. The second event is the 2011 Tohoku earthquake, which also caused tsunamis and earthquakes. Both of these seismic events caused massive damage in Japan and shifted the yen's trading patterns.
Apart from the above examples that have started initially as a country-specific problem, there were many other events like the World Wars and the like that have affected currency in so many ways.
How Do I Limit The Geopolitical Risk I Face?
There is no way for you to completely eliminate geopolitical risks when trading the forex market. However, there are steps that you can take to limit the risks that you face.
One of the biggest things to do is to diversify. Diversifying can help you limit the risk that you take when trading in the forex market. If you diversify, you will be able to diversify your investments, which can lead to a reduction in exposure to geopolitical risks.
Of course, it is still important to keep in mind that diversifying does not eliminate all of your risks, and it will not allow you to place all your eggs into one basket. However, it can help you limit the risk that you face.
Another thing you can do to lower the risk you experience due to geopolitical events is to limit your exposure to the country. If you do not want to trade currencies of a certain country, then you should not trade those currencies. This is because a certain country's currency can be affected by certain events that are not related to the country at all. In other words, specific countries tend to be at higher risk than others, so avoid trading in their currencies.
Finally, there are investment platforms that have their own risk reduction tools. One of the most common is hedging platforms. Hedging platforms can help you limit the risk that you face by allowing you to "protect" your position by purchasing a put option. As long as the currency keeps trading within the range you set, then you will be guaranteed to earn your profit. If the trading price goes higher or lower than the range that you set, then you will not earn any profits or incur any losses.
To sum things up, geopolitical events can affect the forex market greatly, especially when it comes to major currencies. The main geopolitical events that affect the forex market are related to warfare and issues that are related to the economy. The most common of these are civil wars, political unrest and mutinies. Of course, there are other geopolitical events that affect the forex market are related to natural disasters, epidemics, terrorist attacks, regime changes and more.
While the impact that geopolitical events may have on the forex market is hard to predict, it is always a good idea to stay aware of them. This is because it is possible that events that occur in other countries and not in the currency's home country can lead to a drastic change in the currency's value.
One of the best ways to limit the risk that you face in the event of a geopolitical event is to diversify your investments. This will help you reduce your exposure to the forex market and protect your capital from any risky investments.
Also, it is important to keep in mind that you can use hedging platforms to limit the risk that you face in case of a geopolitical event. For example, if you want to reduce the risk of a major currency, then you can purchase a put option to limit your risk exposure!
Do you need an auto-hedging platform to protect the currencies you're working with? Bound offers you the platform you need to do exactly that! Check out our platform today and enjoy better currency protection for your business.