Success with a forex prop firm requires a knowledge of the market as it is abstracted and engaged with by financial traders, but there also needs to be an understanding of how the outside world can have a major effect on your portfolio.
In some respects, this is stating the obvious; currency pairs represent the exchange rate of two world currencies, so something that affects the value of one currency will affect any of its derivative financial instruments.
This means that an understanding of global events is essential for succeeding at forex, and this, in turn, means an understanding of how war affects the financial market specifically.
Whilst in some respects, the effects of a war on its belligerents are somewhat self-evident, there are consequences that can be rather more surprising either in terms of price action, severity or when it actually hits the market.
In this brief guide, we will explore why war affects forex, what you should do if your portfolio is affected, and some particularly notable examples of wars affecting the forex market.
Why Does A War Affect Forex?
A form of geopolitical risk, war can have a significant multilateral effect not only on the economies of the countries involved but can have a cascading contagion effect on each country’s trading partners.
There are multiple ways in which a war can affect a national currency and, by extension, any currency pairs connected to it, which range from the direct to the abstract.
The most obvious way in which a war affects forex is the damage caused by combat, which can cause a disruption of businesses essential to a country’s gross domestic product (GDP), which in turn can affect the value of the currency related to others.
The effect is similar to a natural disaster, but it can be much more destructive over a longer timeframe.
For example, if a country’s primary exports involve agriculture, the destruction of fields can significantly affect harvests, which in turn affects revenue and the currency potentially for years, if not more.
On a similar tangible level, the brain drain caused by people who lived in each nation seeking refuge elsewhere can affect the countries at war, as well as neighbouring nations.
A more abstract, market-specific way in which investors will typically respond to a war is with a flight to quality, which involves moving risky assets away from economies directly affected by the war.
Wars inherently create uncertainty, and investors will typically respond by putting their money in the safest possible assets.
Finally, wars will typically lead to war economies, where resources are diverted towards manufacturing or buying weapons, which can have a negative effect on other parts of the market.
The recovery following wars can lead to fundamental changes in monetary policy, which can affect the value of a currency pair for a very long time to come.
Notable Examples Of How War Affects Forex
One of the most notable examples in recent years of how a war can affect forex currency pairs beyond the sovereign currencies of the countries involved is the Russia-Ukraine war which started in 2022.
A combination of the damage of war, global sanctions on Russia and an energy crisis that engulfed most of Europe had a considerable effect on forex, causing investors to invest in pairs involving the US Dollar and Swiss franc due to their safe haven reputation.
By contrast, the United States’ participation in the Second World War following the attack on Pearl Harbour helped the value of the dollar to rise despite its involvement in the war.
Some economists have speculated, with little tact, that the war helped to reverse the fortunes of the US economy following the Great Depression, both during the war thanks to the consolidation of a war economy, and afterwards due to the Marshall Plan and a gold standard-like economic system based around the US dollar.
Finally, the Cold War brought with it decades of economic turmoil and a reshaping of the forex economy across ideological lines, but the fall of the Berlin Wall, close to its end, not only brought with it a David Hasselhoff concert but also one of the greatest forex trades of all time.
Stanley Druckenmiller, one of the most successful forex traders of all time, made a significant bet on the German mark, correctly believing that the currency would rally once the complex process of reunification was completed. The gambit was worth millions of dollars.
How Should You Trade During War?
War brings significant economic volatility, and as with other major global events, it is essential to try to avoid trading the news. Give the market some time to calm down and assess the situation.
Your risk management strategies are more essential than ever, given the increased volatility and potential for unexpected situations occurring. Do not use excessive leverage and enforce strict stop-loss order discipline.
Keep track of global news and look for connections between the currency pairs that are in your portfolio and the belligerents of the war. If you are trading a currency which happens to be a major trading partner of one of the participants, they can also be negatively affected.
Consider whether you should invest in a safe-haven currency pair. This typically includes the Japanese yen and Swiss franc, given that neither nation will typically take part in major conflicts.
The US dollar can also sometimes (but not always) grant a safe haven to investors.
Focus not only on the events of the war itself, but also on interventions by central banks both inside and outside of the country.
Major monetary policy shifts can cause significant volatility, and it is essential to keep them in mind if you are making longer plays on a war-torn economy.
What Should You Do If Your Portfolio Is Affected?
If you have invested in currency pairs with a country actively at war, it is important to take decisive action and stick with your decision.
In many cases, volatile economies will stabilise, so it can pay to be patient, whilst in other cases the best move is to sell as soon as possible. Despite how rapidly the situation shifts, maintain a long-term approach and see if your position remains tenable.