DailyFX Tips & Picks: How traders can handle geopolitical risk in the markets

WITH uncertainty comes strong market moves – the latest example being the tense situation in Iraq. The effect on oil markets has not been delayed, and we have already experienced a strong price surge. And oil prices could rise even higher, given market panic. This is the effect of geopolitical risk.

The other geopolitical risk of 2014 has been the situation in Ukraine – which initially led to the Russian stock market tumbling 18 per cent, but with all losses recouped in just a few months.

The short-term effect of geopolitical risk on the market is therefore violent and usually goes in one direction, as investors rush to the exit and speculators enter with their trend-following methods. This is why geopolitical events are favoured by market participants. Short-term technical analysis, which favours breakouts, works very well in these conditions, as the market will overreact to the geopolitical news.

As price moves too far away from its true equilibrium, however, investors with know-how and insight into the situation would take contrarian positions, and this is why we often see a slowdown in markets much earlier than the press can report or assess what is happening in the real world.

While trading with the initial flow is quite straightforward and will usually return handsomely, trying to capitalise on the corrective move is much harder, although it can be done using the Yearly Pivot Point Indicator. The general advice, therefore, is to buckle up and trade with the initial flow only.

Alejandro Zambrano is a currency analyst at DailyFX. Azambrano@dailyfx.com Twitter:@AlexFX00