How To Trade Geopolitical Conflicts Introduction
In this article, we will break down how to trade geopolitical conflicts on the back of the recent conflict in Ukraine. When we are building an understanding of how to trade around geopolitical conflicts, we need to understand which scenarios will have the highest impact on the markets. From the most binary to the fuzziest implications, understanding the variety of possible scenarios is crucial. The binary scenario will have the biggest impact on the market since it is absolutely clear what it implies. The fuzzier the implication of the news gets, the harder it will be for us to trade with size. We also cannot forget the diminishing power of the 24/7 rolling news. It is in these times that we need to be 100% clear on what we want to see and hear. Anything else can have devastating effects on our P&L.
Let’s get some recent examples from the conflict in Ukraine and discuss, how traders can interpret events like this one. If you like this type of article, don’t forget to check our previous articles on news trading: Trading the Fed Rate Decision.
Let’s get started.
Tip 1: Building The Trading Scenarios To Trade Geopolitical Conflict
First, let’s make it clear that any war is a terrible disaster for everyone who is negatively impacted. As traders, we need to identify possible opportunities in the markets and react to the best of our ability. We need to stay in control in these volatile and emotional times and wait for the opportunities we understand the best. This leads to building clear trading scenarios. Mapping the terrain of all possible cause-effect relationships and their implications on the market.
So the first question we need to ask is:
“What is the binary non-emotional effect of the news”?
In case of the Ukraine, it means that there either will be or won’t be an invasion. Anything else is some degree of movement towards one or the other scenario. With any news coming in, it is all about understanding if the particular piece of the news brings the invasion closer, triggers the invasion, or further away from happening of invasion. Understanding the scenarios, their binary and non-binary effect is step number one in trading the geopolitical crisis.
Listen to the video directly from the trading floor directly related to Tip 1:
If you want to dig deeper and learn how to build an understanding of what has been priced in and what has not, see the video down below where Richard breaks down the OPEC announcement about Oil production starting with the most expected scenario, the main narrative. He then continues and builds less expected scenarios and their possible implication on the price. What makes the move in the price of Oil to continue or reverse after the announcement? And how you can prepare for that.
Tip 2: Understand The Products You Are Going To Trade
Although there is no exact guideline such as: “trade these markets in this order”, we can use two general principles.
- Principle 1: any bigger geopolitical conflict triggers the risk-off sentiment. Therefore with a certain degree of error, we can say equities should offer, Gold should rally.
- Principle 2: Anything that is happening now, has happened in some shape or form in the past. The future is never exactly the same as the past but it often rhymes. Therefore understanding what has moved in the past on similar types of conflicts will give you clues into the current conflict. Time to revisit the 2014 conflict in Ukraine for a proxy to what markets react the best and in what fashion.
Using these two principles, we now should formulate the strategy:
“which products we will trade and how we are going to trade them”
If you want to expand Tip 2, we have written a piece on how to trade macro events: Top Best Practices To Step Up Your Macro News Trading Game.
Tip 3: Understand The FOMO Element
With a lot of non-binary news constantly coming in these can be really tricky times for less-experienced traders because of the FOMO. You simply don’t want to miss the big moves but priority number one is BE IN CONTROL. More often than not, we see people losing money early in a day not to have the capital to trade in the afternoon when better opportunities crystalized. So unless you know exactly what you want to see and your scenario is in play, sit tight and wait for the best opportunity. Listen to what Isaac has to say directly from the floor.
Tip 4: You Don’t Have To Trade
This goes hand in hand with the FOMO-related tip number 3. There will be times when market gaps and it will be hard to trade around those gaps. Why? A lot of opportunities around the positioning will be washed away and new market participants will have to step in. We need to give the market more time to tell us when it wants to move next. This requires patience. Listen to what Richard got to say about this:
Now as you have read all the tips there is one last recommendation. If you have never traded geopolitical conflict before, step back and just be a curious observer of cause-effect dynamics on the markets. Map terrain, screenshot, document, write – do whatever it takes to learn as much as possible from this situation. Build a case study so you navigate yourself as best as you can in the geopolitical conflicts of the future.
Bonus: Trading The Iran-US Geopolitical Conflict
Last but not least, if you are interested, see the bonus of how this Elite Trader trades the geopolitical conflict between the US and Iran and read the commentary below to understand the narrative, product selection and strategy this Elite Trader used.
Understanding The Narrative
“At the beginning of 2020, there was a dramatic escalation in tensions between the US and Iran after Trump ordered an airstrike on Jan 3rd that killed top Iranian military commander Soleimani. After this, Iran pledged to take “severe revenge” and markets started getting nervous about the prospect of a military conflict between the two nations.
Oil and Gold surged on geopolitical risks after the US strike while equities and risk-assets sold off. The markets were nervously awaiting Iran’s response although there was hope for a diplomatic solution and an avoidance of Iran’s retaliation.
At around 11 pm London on Tuesday 7th January, various Twitter sources started reporting that Iran started firing missiles at Iraqi bases that house US soldiers. With both US and European cash markets closed, futures were slow to react. However, as more sources started confirming the attack and more specifically when Iran Revolutionary Guard confirmed that they were hitting US forces, markets were on the move. Oil, Gold, and US bonds started rallying sharply while S&P futures started selling off aggressively.
The elite trader started buying oil and gold very aggressively (around 200lots in each), buying T-notes (300+ lots) and selling S&P (200+ lots). Executing with his usual trading style he kept managing the trades in these 4 markets by adding and scaling out as he saw fit. As the news kept getting more and more traction so was the market reaction. The moves from 11 pm to 11.40 pm were quite large across oil, gold, bonds, and S&P and he managed to capitalize big on them.
After the initial reaction to the attacks, the market was fearing the worst (potentially a full-blown war between US and Iran) and thus the very big risk-off move. However, soon it was reported that there were no US casualties, and Iranian Foreign minister Zarif said that IRAN CONCLUDED PROPORTIONATE MEASURES, NOT SEEKING WAR. In addition to this, Trump tweeted saying “All is well! Missiles were launched from Iran at two military bases located in Iraq. Assessment of casualties & damages taking place now. So far, so good!”
All the above feeding into markets made participants realize that the situation seemed like it was contained and that the US probably wouldn’t have to retaliate back. This caused the V-shape reversal in all markets with Gold, Oil, and US bonds selling off and Spoo rallying retracing the original move. Our Elite Trader managed to reverse his initial risk-off positions and sold Gold and Oil while buying S&P to add to his PnL. By 3 am most markets had retraced most of the moves.
On the morning of Wednesday 8th of January, after this massively volatile overnight session, the European session was a lot quieter. Equity markets kept drifting higher while safe-haven assets (Bunds/Gold) and Oil kept drifting lower as markets were relieved on the limited response by Iran and the fact that there were no casualties. Trump was scheduled to address the nation at around 4 pm London time and it was clear that this would be the catalyst for the next move.
The market price action was indicating that Trump was probably going to sound harsh on Iran but refrain from announcing further conflict or retaliation after the latest attacks. If that was the case we would expect probably another leg of risk-on (but possibly short-lived as this was now priced in). If on the other hand, he chose to escalate tensions further, then we would expect risk-off to hit the markets again.
Trump started his speech by saying that IRAN APPEARS TO BE STANDING DOWN. This was the first hint that he acknowledged that the Iran attack was limited and that hinted that he would not choose not to retaliate. Our Elite trader instantly sells 90 lots in Oil and then sells 80 lots in Gold and buys 280 S&Ps.
As Trump continued talking he struck a very de-escalating tone by saying that he was seeking a diplomatic solution and peace with Iran. This was the best that the market would hope for and as result risk assets rallied and safe-haven assets and oil sold off to completely un-price any war premium. The elite trader played for a final risk-on move by adding to his positions and scaling his positions out as he started seeing signs of exhaustion in the moves.”
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Thanks for reading and until next time, trade well.