Last Updated on March 18, 2024
Many traders wonder whether they should trade during times of world conflicts and market instability, and rightly so. When the economy is unstable, or the geopolitical risk grows, markets can become an unpredictable environment with lots of unknowns. However, not everything is doom and gloom, and the more experienced traders can identify arising opportunities even in fragile markets. This guide offers a few tips on how to make the most out of your trading activity during times of world conflicts and global instability.
The Specifics of Trading in Times of World Conflicts and Instability
Looking at the market history, you will see a clear trend – markets move in cycles. Every decade or two, we have some sort of crisis event. These can range between geopolitical tension, local conflicts, global instabilities, financial crises, etc. Most of the time, the effects of these events ripple through the entire world economy. They affect trade, devalue currencies, cause supply disruptions, increase inflation, and more.
The magnitude of these events varies. Their overall impact can last anywhere from a few days to several years.
Markets are usually the first to react. However, most of the time, the immediate market reaction is chaos. News is flying left and right, some exaggerating the events, causing even further stress. When things calm down, what determines the state of the market is how market participants interpret the ongoing situation and the possible impact of the particular event on their portfolio or the entire market. The first thing most traders do is hedge their portfolios. Others try to find and capitalize on opportunities arising in a nosedive market.
Nevertheless, despite the different options for playing the market, trading during times of world conflicts and instability is a tricky process. Many traders struggle to cope with it. The process gets even more challenging for those trading on leverage. Mainly due to how growing volatility can often wipe one’s portfolio out in a matter of minutes.
Types of Destabilizing Events
Many traders mistakenly believe that financial markets are affected only by intrinsic events. Such events can include a country’s or a company’s default, a FED or an ECB interest rate announcement, or more. However, the truth is that financial markets can be affected even by events that don’t seem so relevant at first.
The same goes for the magnitude of events. It doesn’t take a war or a global financial meltdown to destabilize markets. Often, even small-scale events can have significant consequences.
Traders should consider the event’s nature and magnitude when considering how to play the markets. Here are some common destabilizing market circumstances and how they have affected financial markets in the past.
Global Conflicts
Terrorism, armed conflicts, civil unrest, international economic and political sanctions, embargoes – these and many other factors directly or indirectly affect the financial markets and investors’ behavior.
For example, wars have led to the most significant drawdowns to global markets in the past. When Germany attacked Czechoslovakia in 1939 and France in 1940, the S&P 500 fell by 20.5% and 25.8%, respectively. On the day after the Pearl Harbour attack, the index fell 11%. During the 1973 oil crisis, the S&P 500 nosedived by over 17%.
Such periods are accompanied by lots of company defaults, booming volatility, and an overall sense of insecurity taking over the market.
However, not everything is doom and gloom. While for the untrained eye, these stats will quickly lead to the conclusion that everybody should sell to protect their capital when the world is in turmoil, this isn’t always the case.
For example, from the beginning of WW2 to its end, the Dow Jones was up more than 50%. During both world wars, the stock market skyrocketed by 115%. The wars were also followed by some of the most notable economic booms since whole nations had to be rebuilt.
Global instability might seem like a net long-term negative for one’s trading portfolio. However, history tells us that the opposite can often be true. Based on the context, the preferred trading strategy, and markets of interest, even adverse events can open up opportunities.
High-Inflation Periods
Inflation works in the shadows and usually doesn’t directly or immediately affect one’s capital, or at least that is how many think. However, it is one of the most devastating events for one’s financial health.
Here is an example. In June 2022, inflation in the US hit 8.6%. This means an individual with $10,000 capital will lose $860 worth of purchasing power in a year. Scale this up for someone with a $100,000 portfolio, and you get the picture. For a trader, their return will also get a massive hit. At the same time, trading costs don’t get lower to compensate for the high inflation.
Inflation can be fueled by many triggers, including supply/demand instabilities, labor market disruptions, economic slowdowns, monetary policy developments, etc. Inflation rates can vary, but the higher they are and the longer they last, the more devastating their effect is.
For example, the most significant inflation ever was measured in Hungary after WWII. The country experienced hyperinflation with a monthly rate of 41.9 quadrillion percent (41,900,000,000,000,000%) in July 1946. As a result, prices doubled every 15.3 hours.
To protect their portfolios against high inflation periods, traders usually choose assets designed to hedge against the loss of purchasing power. Alternatively, instruments with a high probability of generating additional income and increasing value in the face of rising prices. Many assets have historically performed well in periods of high inflation, mostly commodities.
Inflation is often referred to as a “portfolio killer.” That is why trading during high-inflation periods requires mastery and understanding of the asset classes that perform best when purchasing power is suffering – especially when it happens on a global scale and when there is nowhere to hide.
Black Swan Events
Black swan events hit hard and are unexpected, catching traders off-guard. Such might include weather anomalies impacting crop production, a one-off flash crash that tumbles the market for a few minutes, a global pandemic, or any other events traders can’t prepare for.
For example, in March 2021, the Ever Given ship got stuck in the Suez Canal and blocked the busiest and most critical trade route in the world. The blockage of the vital waterway disrupted global supply chains and the delivery of goods from China and South Asia to Europe. It also disrupted crude and refined product delivery from the Persian Gulf and India to Europe, naphtha from Europe to Asia, and crude from the Persian Gulf to US Gulf. The Ever Given ship wedged in the Suez Canal cost global trade $400 million per hour. The ship left the canal a few months later, in July of the same year.
The impact of this event rippled through different sectors, causing disruptions around the market. Some companies needed months to get their supply chains up to speed.
Or we can take the 9/11 terrorist attacks, which led to a sharp stock market plunge and wiped out over $1.4 trillion in value from US markets. The following week, the Dow Jones Industrial Average lost 14%, while the S&P 500 and NASDAQ losses were 11.6% and 16%, respectively.
Due to the growing interconnectedness of global markets, investors and traders must be aware of the increasing importance of black swan events and their potential implications on portfolios. The bottom line is that even if a particular factor doesn’t indicate any relevancy to your trades at first, your positions might be impacted too through its links to other sectors and industries.
Tips on Trading in Times of World Conflicts and Instability
Periods of market uncertainty can trigger a plethora of emotions in a trader. Some might be scared of losing their capital. Experienced traders are more likely to feel calm and relaxed. Active traders might be excited about the opportunities arising from increased volatility. There is also the group of traders experiencing FOMO while observing how others are profiting in a downward market.
No matter the group a trader falls in, one thing is clear – trading during turbulent times is way more challenging than trading when the overall market sentiment is positive. Here are a few tips on making the most out of trading during market instability and protecting your capital.
Beginners Might Consider Hedging or Head for the Exit
Beginner traders panic and make rash moves when the market goes down since they are less likely to have experienced similar crises. When things go south, it is critical to remain calm and let your risk controls (e.g., stop losses, and hedging strategies) do the job. This is a fundamental principle proposed by the industry’s finest.
About investing, Warren Buffet says: “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.”
Commodities trader Ed Seykota says: “The elements of good trading are: (1) cutting losses, (2) cutting losses, and (3) cutting losses.”
During market downturns, traders can usually take two approaches – a passive or an active one.
The passive approach is to close your positions and head for the exit. Halting trading activity for a while can be beneficial in several aspects. First, it protects the capital by locking the profits. Next, it is a life-saver for traders that don’t feel comfortable when chaos starts ruling the markets. Having to interpret the signals from technical indicators, alongside the pressure from the market spiraling down, can often be too much to handle. Leaving your head to rest might be the best move in such moments. Third, it leaves room to plan the next move or possible alternative portfolio allocation. Once things calm down and you have a plan, you can get back in.
The active approach is to hedge your portfolio by investing in assets better suited to the new market realities. Times of world conflicts and market instability usually require more defensive trading and a focus on hedging strategies. These typically include conservative investments or assets with timeless value, proven to have held up well in crisis periods.
Trade Only If You Have Enough Capital
While turbulent market periods can open many opportunities, it is better to take a more passive approach if you aren’t confident in navigating the uncertainty or are operating on limited capital. Bear in mind that this is usually a high-risk environment. There’s a possibility of losing more than what you can potentially gain. When markets start going down, losses can quickly spiral out of hand, especially for traders using leverage or without proper risk management mechanisms.
That is why it is essential to follow trading’s golden rule – trade only with what you can afford to lose.
Furthermore, it is essential to consider the worst-case scenario of losing your entire portfolio. For example, if you are trading with $10,000, and losing all of it can possibly throw you out of trading for a while, you have a major red flag to reconsider the capital you are trading with. If you can’t bear losing the money you have on open positions, then you are playing a game of very high stakes.
It is essential to always trade with money that you can afford to lose without any impact on your lifestyle or trading activity perspectives. Also, avoid trading with other people’s money, including capital provided by your family or friends, if you are unsure whether your strategy can handle market fluctuations.
Remain Calm and Relaxed
Naved Abdali, a writer focused on psychology investing risk and booms and busts cycles, writes: “Greed and fear are both good and healthy for an investor and capital markets as a whole. Emotions are like fire, beneficial if controlled, destructive if wild.”
More often than not, traders fall into the latter scenario. Seeing the market nosedive in front of your eyes is traders’ worst nightmare. It can cause anxiety and panic and make you let your emotions take control of you. The industry’s finest have perfected the art of remaining calm when everything surrounding them bursts in flames. However, this remains challenging for the rest of us.
However, market drops are a part of the process and, most importantly – a common one. That is why the first thing you should do when markets go in an unfavorable direction is to acknowledge that this is temporary. Just look at the chart of the S&P 500 or any other major index since its inception. The trend is firmly positive, and market crashes or instabilities are just small hurdles in a long-lasting trading marathon.
To ease your peace of mind, there are three main things to work on:
- Enhance your risk management controls – have a stop-loss, a hedging strategy, and a Plan B;
- Trade with capital that you can afford to lose – a point that we already made, yet one that can’t be stressed enough;
- Keep your eyes on the bigger picture – lean on your expertise and knowledge of market mechanics, and don’t end up chasing short-lived opportunities.
Final Thoughts on Trading During Market Instability
Whether one should be trading during times of world conflicts and instability depends on their strategy, goals, and experience. In any case, traders should be familiar with the potential impact of market-disrupting events. That way, they can be ready to protect and grow their portfolios even in a highly-unstable environment. Fortunately or not, the trader of today has to be more informed, skilled, and prepared since the risk universe has never been as expansive as it is nowadays. Check out our dedicated article if you want to learn about the possible ways significant events can affect financial markets.
