The impact of geopolitical news on trade

In this article, learn about the different types of geopolitical news, their impact on market sentiment, and how sentiment can move asset prices.

Why is the word “sentiment” so often used to describe market reactions? This term seems to be reserved for novels and mushy poems, but in the context of financial markets, it is widely used to describe the emotional and adaptive responses of traders to events that affect asset prices.

Negative emotion is equated with fear and gloom, while positive emotion is compared with optimism and confidence. Another expression often used in financial articles is: “investors ignored the news”. It is about indifference, another human emotion, or rather, in this context, the perception that the news is not important enough to influence trading and investment decisions.

Geopolitical events affect supply and demand

The geopolitical causes of negative and positive sentiment are different, but whether these events will provoke a lasting response boils down to one question: does the cause pose a significant risk to the flow of supply and demand? demand for the assets on which the financial instruments are based?

This is the big question that traders and investors must answer themselves when making their decisions under pressure. To take an example, a civil war breaks out in a country whose main export is gold. After the initial shock of the news, gold traders must assess whether the conflict will disrupt supplies of the precious metal used in jewelry making and manufactured goods. Without gold, most of the electronic devices that we are so used to in our daily lives could not be made. Therefore, gold traders and mining stock investors are careful to sift through news articles about the country in question and check analysts’ assessments of the potential impact on gold supply.

If the news flow points to increasing risks to the gold supply, traders and investors may start buying the various instruments used to trade gold in anticipation of an increase in price due to a supply limit. Another scenario could be that the conflict subsides quickly and there are no risks to the gold supply, in which case sentiment may be cautious, but the reaction will not go so far as to trigger a bullish trend in the gold markets.

This example is just one of the thousands of reactions, small or large, that occur every day in the markets. Supply and demand are based on the daily needs and wants of the world’s population, which explains the sharp focus on geopolitical events that can affect vital trade routes.

Research into geopolitical news and markets

The effect of geopolitical news on market sentiment is not only based on the observation of cause and effect in the markets, but has also been confirmed and calculated by academic researchers.

The Geopolitical Risk Index (RPG) was developed by Dario Caldara and Matteo Iacoviello specifically to study the impact of geopolitical events on the financial markets. According to their research, 75% of market operators are concerned about geopolitical risks, and market reactions are correlated with the frequency of reporting of adverse geopolitical events in the media.

Caldara and Iacoviello define geopolitical risk as “the threat, realization and escalation of negative events associated with wars, terrorism and all tensions between states and political actors that affect the peaceful course of international relations”.

In practice, this definition can be expanded to include controversial elections, pandemics, changes in international trade agreements, and events related to high-profile business leaders and politicians whose scope can and does affect markets internationally.

Impact of new geopolitics on markets

The GPR index tracks market reactions to news events. For example, as the COVID-19 pandemic escalated, the index fell from the level of 74 in December 2019 to the level of 138.42 in January 2020. At that time, supply-side risks increased as countries closed their borders and imposed travel restrictions to prevent the spread of the disease.

The RPG index has an inverse correlation with market sentiment. The higher it is, the more market sentiment falls as investment, employment and stock market returns come under pressure.

To conclude this article, newcomers to the trading world should be aware of the possibility of sudden changes in sentiment due to geopolitical events, and practice good risk management accordingly.

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This content does not and should in no way be interpreted as containing investment advice or recommendations, an offer or a solicitation to trade in financial instruments. Please note that this marketing communication is not a reliable indicator of any current or future performance as circumstances may change over time. Before making any investment decision, you should seek the advice of independent financial advisors to ensure that you fully understand the risks involved.

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