Forex and many other tradable commodities have a significant risk profile that investors must watch out for before taking their positions. Current events are the most noteworthy factors that affect trading. However, future events, especially in the geopolitical sphere, have their impact on the forex market.
Protecting against geopolitical risk might be easy and an important lesson when an investor is learning the topic, how does forex trading work? However, surprise action in the political sphere of a dominant world power might catch traders by surprise, tanking their investments overnight. The most common issue noted in the forex markets is its volatility. Indeed, unlike stocks, forex prices change within a short time.
The Currency Market
As is in the name, the currency market involves the exchange of one currency for the other. While the intention of exchanging currency might not be solely for gain, the minor price differences at the time of exchange make it profitable, and that is why it invites traders from all over the world.
The currency market still holds the record as the largest in the world, meaning it covers every bit of the earth where meaningful commercial activities exist.
Countries buy currencies to enable them to import foreign goods and protect their economies from shocks arising from the political, environmental, or economic sphere. Individuals trade currencies when they visit other countries. Large financial institutions, such as banks, are the most involved in the business. Central banks help keep a particular level of foreign currency pair correlation to help stabilize their local currencies and economies, and further help local banks have access to foreign currency.
While any currency can buy and sell goods in the markets internationally, the size of the US economy and geopolitical might make the USD the most regarded tool for international trade. The USD also holds the record as the largest reserve currency in the world.
Since the USD is the largest currency in international trade and the most preferred by countries as a reserve, it is the standard when setting the price for other currencies. In addition, the status of the dollar makes it a powerful political weapon in international politics.
Geopolitics and the Forex Market
Geopolitics is a risk that affects the forex market, meaning that whenever a policy in one part of the world is set in motion, the price of one currency or a group of them moves up or down. Geopolitical risk goes hand in hand with the size of an economy. The largest economies often spark considerable shock waves in the currency markets than the smaller economies.
In a nutshell, the civil unrest in France about pension reforms has a more substantial bearing on the currency markets via the Euro than the political situation in Sudan, which only influences the domestic currency. Often, traders base their trades on currencies with sound economic and political environments. On a scale, France stands at the top of Sudan in political and economic soundness, making the Euro most preferred.
In the decade, events such as Brexit, unrest in the Middle East, the war in North Africa, and recently, the Russian invasion of Ukraine have all shaped the currency markets. Brexit, for example, devalued the pound by over 20 percent since the 2016 referendum on leaving the EU.
Indeed, Brexit also made the pound more volatile in the period, making it highly risky to handle when taking a position in the forex market.
The Russian Ruble also took a significant hit when Russia actualized its plans to go into a violent conflict with Ukraine. As of October 2022, the currency shed about 20 percent of its original value before the war.
While wars and events like Brexit are easy to see, surprise devaluations like the decision taken by China in 2015 are difficult to manage. Such events catch forex investors by surprise, leading to massive losses overnight.
Politics and the currency market go in hand. Countries with more stable economies such as those in Europe and North America enjoy the largest share of the forex market in terms of the currency that is exchanged. Decisions made in those economies have a tremendous impact on the forex market.