It may seem that political events are very far from us and our daily life, especially for the young.
However, they have immense relevance to and an impact on the world’s economy, especially on the Forex market, where different currencies are traded.
Where there is political instability within a country, it can result in large fluctuation or volatility in its currency. But what does this mean, and why does this happen?
Why Political Instability Affects Forex Volatility
Whenever the political situation in a country is unstable, it generates uncertainty.
Just imagine: if your school’s future is uncertain, and its principal and teachers change every now and then.
You will never know what your school will look like tomorrow. The same feeling applies to investors when a country’s government is unstable.
They are not certain as to whether the economic policies will change, or whether there will be a rise in taxation or a new set of regulations.
Hence, they remain cautious and sometimes could even become terrified to invest.
Due to this caution, investors shift their funds to the safety of currencies like U.S dollar or Swiss franc, commonly referred to as safe-haven currencies.
This is a flight to safety, and such events create volatility when everybody sells one currency and buys another at the same time, creating big swings in currency pairs.
Political Events and Their Impact on Forex
- Elections: Elections are a great event for every nation, hence volatility occurs in markets. Even the expectation of a new ruler can shift currency values. For example, the 2016 U.S. Presidential election led to a big surge in the U.S. dollar due to investor confidence in new economic policies.
- The so-called Brexit, the decision of the United Kingdom to leave the European Union, presents one of the most remarkable cases concerning changes in currency value seen in recent times. The sharp decline of the British pound against other currencies has been because investors are not very sure what this detachment will entail for the UK economy.
- Wars and Conflicts: At the time of war between two or many nations, the currency of both generally falls. War places stress on the economy and erodes investor confidence. For example, the Russian Ruble and the Ukrainian Hryvnia showed huge volatility during the war between Russia and Ukraine.
- Government Crisis: In case any country’s government collapses or goes into crisis, then the currency of that country usually weakens. Investors pull out their money and wait for things to go back to normal.
How to Manage Forex Volatility
If you trade Forex here are a few tips to deal with political instability:
- Stay Informed: Following world news can help you understand which currencies will be affected. What seems small can have a big impact on the market.
- Diversify: Instead of putting all your money in one currency, diversify across several to spread the risk.
- Use Stop-Loss: This feature in your trading session times by JM will sell a currency if it falls to a certain level, so you don’t lose too much.
- Follow Economic Indicators: GDP growth, inflation and unemployment rates are useful to predict currency stability. Political instability can change these indicators so following them can give you an edge.
How to Measure Volatility in Forex Pairs
There are a few indicators of Forex volatility, including the Average True Range, which refers to the range of movement of a certain currency over some period of time.
The greater this value is, the higher the volatility.
Other tools that measure volatility are the Volatility Index or VIX, which pertains mainly to the stock market but also may imply anxiety in the market in general, affecting the Forex pairs.
Comparison Table of Safe-Haven vs. Volatile Currencies
Here’s a quick look at how different currencies react to political instability:
|
Currency Type |
Examples |
Reactions to Instability |
Usage |
|
Safe-Haven Currencies |
USD, CHF, JPY |
Often increase in value as investors seek safety |
Long-term investments |
|
Volatile Currencies |
Emerging Market Currencies (TRY, ZAR) |
Often lose value due to high-risk perception |
Short-term trading opportunities |
Safe-haven currencies like the U.S. dollar and Swiss franc are viewed as stable and tend to appreciate during times of global instability.
In contrast, emerging market currencies, such as the Turkish lira (TRY) and South African rand (ZAR), often lose value when political issues arise, as they’re considered riskier.
The Ripple Effect on Other Markets
Forex volatility doesn’t just affect currency traders.
When major currencies move, it affects global trade, stock markets and commodity prices.
For example if the US dollar strengthens a lot, it will make American products more expensive abroad, less exports.
This can affect companies, workers and even everyday people around the world.
Conclusion
Political stability is one of the most important factor to maintain currency values. Forex traders might benefit from volatility but it’s also risky.
Traders should always be aware of the political landscape and consider it when making decisions.
So, is political stability important for Forex traders? Yes. The more stable a country is, the more stable its currency will be, which is good for traders who want less risk.
However, some traders thrive in volatile markets and seek out opportunities during times of instability.