The Importance of Political Risk as a Driver of the Foreign Exchange

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From a theoretical perspective, the notion of risk is as detrimental as it is inevitable for investors. The same principle cannot be applied in reality, however, as the diverse nature of the financial market means that there are several derivatives that are actively driven by social and political risk.


Take currency, for example, which is traded on the foreign exchange and renowned for its volatile price movements. It is also driven by the concept of political risk, with everything from major events to economic data releases capable of informing individual trades.

How Does Political Risk Drive Activity in the Forex Market? 

We have seen significant evidence of this during the last year, with major political events such as Brexit and the unexpected election of Donald Trump as U.S. President triggering numerous peaks and troughs in specific currencies. The pound (GBP) sunk to a 31-year low in the immediate aftermath of the referendum vote, for example, while it also plunged similar depths after Prime Minister Theresa May announced her intention to sever all access to the single market and pursue a so-called 'hard' Brexit in the autumn.

In contrast, the U.S. Dollar (USD) made significant gains on the back of an impressive economic performance during the fourth financial quarter of 2016, while Trump's election also provided an initial boost to the currency as both the GBP and the Euro (EUR) wavered. 

It is during these instances that trading volumes rise, and this is due primary to the underlying nature of the market. As a derivative asset, the value of currency is not linked to the ownership of a specific commodity, meaning that traders can speculate and profit even in a depreciating marketplace. Not only this, but the fact that currencies are traded in pairs enables investors to base their speculations on core political trends, as they back one against another to secure either short or long-term gains.

How Technological Advancement Has Also Helped Political Risk to Drive Forex Trading

Of course, the fact that political risk remains a key driver of forex trading means little unless you are able to follow and analyze such trends. Fortunately, resources such as ETX Capital feature live newsfeeds and a host of real-time analytical tools, which allows traders to monitor political trends as they develop and understand their impact on the market.

All in all, it is easy to see how political risk drives and informs currency trading in the modern, and this is a trend that is set to continue. It will certainly be evident in 2017, as Trump's chaotic Presidency continues and Europe prepares for two major elections in France and Germany.

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