In this article, you will 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 reserved for novels and mushy poems, but in the context of financial markets, it is widely used to describe the emotional and adaptive reactions of traders to events that impact asset prices.
Negative feeling is equated with fear and gloom, while positive feeling is compared with optimism and confidence. Another term 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 affect trading and investment decisions.
Geopolitical events influence supply and demand
The geopolitical causes of negative and positive sentiment are varied, but whether these events will elicit 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 for 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 interfere with the supply 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 life could not be made. That’s why gold traders and mining stock investors are careful to comb through news articles about the country in question and check analysts’ assessments of the potential impact on gold supply. gold.
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 a rise in price due to a supply. limit. Another scenario could be that the conflict dies down quickly and there are no risks to the gold supply, in which case the sentiment could be cautious but the reaction would not go so far as to trigger a trend bullish in gold markets.
This example is just one of the thousands of reactions, minor or major, 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 keen focus on geopolitical events that could impact vital arteries of commerce.
Research on geopolitical news and markets
The impact 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 financial markets. According to their research, 75% of market operators are concerned about geopolitical risk, and market reactions are correlated with the frequency of reporting on 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 broadened 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 influence markets internationally.
Impact of new geopolitics on the markets
The GPR index tracks market reactions to news events. For example, when 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 the time, supply-side risks soared 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.
In conclusion to this article, newcomers to the world of trading 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 contain 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 advisers to ensure that you fully understand the risks involved.