Most successful investors and traders all share a common thing – they started their journey by understanding how major events affect financial markets. This bird-eye view allows market participants to understand market mechanics and lay the perfect foundation for their financial market journey. Once traders wrap their heads around the broader picture, they can easily zoom in on the corners of the financial ecosystem where they would like to develop their skills, be it stocks, commodities, or others. In the following article, we will help you understand how major events affect financial markets and how to make the most out of them.
What Are Financial Market Events and Why Are They Important?
Financial market events determine the behavior of market participants. These events can come in various forms. However, what is common for all types of financial market events is that they provoke a reaction from traders and investors. This reaction usually is to buy or sell an instrument or retain a passive position.
Based on their knowledge and expertise, market participants try to interpret the possible impact of a particular event on their portfolio or the entire market. The ability to accurately read the consequences of market events is a crucial competence that long-term investors and short-term traders strive to get better at.
Being able to predict and play financial market events allows market participants to build a sustainable and high-performing risk management strategy. They can also make short-term bets to catch a looming short-lived market opportunity or hedge against unfavorable impacts.
Based on their nature and magnitude, events can cause financial market booms or crashes. Often, events that look potentially significant on the surface actually don’t provoke any market reactions once they materialize. This unpredictability is what makes financial markets probably the most complex system we have ever built.
However, this doesn’t mean that financial markets and the events that affect them don’t abide by rules. Just the opposite – history has taught us that, despite all their unpredictability, markets aren’t all chaos. There are behavioral patterns that have been proven repeatedly. The ability to understand and interpret them is now a critical trait of successful traders.
Types of Events that Affect Financial Markets
The first step to understanding how major events affect the financial markets is to get familiar with the different types of events.
Financial market events vary in terms of their nature and magnitude.
Many make the mistake of thinking that financial markets are affected only by intrinsic events like a country defaulting on its debt, a company crushing its earning estimations or a whale entering the market for a particular asset. Just the opposite – often, events that might seem partially related to the course of development of financial markets might end up having a massive effect.
This is also valid for the magnitude of events. It doesn’t take a war or a global crisis to destabilize markets. History remembers cases where even small traders, buying and selling futures contracts from their homes, have crashed the entire market.
However, it is essential to note that being familiar with the types of events that affect financial markets isn’t enough. The most successful traders specialize in understanding the links and the so-called “ripple effects” of different events. For example, why and how can the default of a corn producer in the US affect the financial results and operational stability of an alcoholic beverage company in Europe? Or why a geopolitical conflict pushes the price of steel up?
Before getting the details, however, beginner traders should start by getting to know the different types of events that can affect their portfolios:
Macroeconomic events come in all shapes and sizes. They aren’t just limited to economic or financial nature.
The most significant macroeconomic event that determines the market behavior is the supply and demand ratio. The difference between those looking to buy and those looking to sell is the number-one factor affecting the prices of instruments. The rule of thumb is that the market remains flat when both are in equilibrium. When the supply is higher than the demand, the price decreases. And vice-versa – when the supply exceeds the demand, the price increases.
Other notable macro events from an economic character are the monetary and fiscal policies, the publishing of leading indicators, or financial performance data. Some examples include different indices (Consumer Confidence Index, Purchasing Managers Index, Consumer Price Index, Index of Industrial Production, and more), inflation forecasts and reports, quarterly job results, economic predictions, interest rate decisions, all types of regulations related to a particular market, and more.
As their name suggests, the microeconomic events take place on a company level. These events can range from earning reports and performance data (revenue, quarterly profit, etc.), mergers and acquisitions to developing a new line of products or services, personnel changes at a board level, reputational issues, regulatory fines, or more. The bottom line is that these events can lead to internal shifts within the company (e.g., suspension of dividends) that can significantly affect the perception of it in the eyes of investors.
All this will then be reflected in the price of the stock. The magnitude of the change usually depends on how drastic and sudden these developments are. For example, unexpected events will take a larger toll on the shares’ price than those that are well-known in advance and investors have had enough time to prepare for.
Here we should also mention news sensitivity. While news can affect all corners of financial markets nowadays, its effect hits hardest on a corporate level. Even fake news today can trigger a reaction in traders and make them act irrationally (out of fear or greed) before waiting for confirmation. This poses a significant risk to both – companies and their investors.
Financial markets don’t react only to economic or financial factors. They are also highly reflective of events, which can be very diverse.
For example, let’s take the weather forecasts. They are a crucial factor in commodities markets. Based on the long-term weather forecast, traders can predict the potential trends in crop production and better time their positions.
There are also black-swan events that can affect the market in its entirety. For example, the COVID-19 pandemic is sort of a black-swan event, although the world had been tracking the spread of the virus for a long time. However, few would have anticipated the boom of lockdowns across the globe, which disrupted supply chains for all types of goods.
Another black swan event that recently took a toll on global markets was the case of the Ever Given. It was a ship that got stuck in the Suez Canal and blocked the most critical trade route in the world. The event affected the oil price, skyrocketed the price of cardboard boxes due to growing online shopping, disrupted global trade, causing shortages of goods, changed the maritime insurance industry, questioned the effects of globalization, and more. All these consequences rippled through different sectors, causing disruptions all around the market.
Speaking about ripple effects, it is essential to note that, due to the growing interconnectedness of global markets, investors today have to be aware of a continuously-expanding risk universe looming over their portfolios. The bottom line is that even if a particular factor doesn’t indicate any relevancy to your trades at first, through its links to other sectors and industries, your positions might be affected as well.
Natural disasters, terrorism, war, civil unrest – these and many other factors can pose direct or indirect effects on the financial markets and investors’ risk tolerance.
How Can Events Impact Financial Markets
There are three main ways in which events, regardless of their nature, can impact financial markets.
First, they can trigger an adverse reaction like a massive sellout, leading to a temporary or long-term crash. Investors’ fear usually triggers such situations. The massive and simultaneous outflow of investors leads to a sudden and typically substantial price decline.
The other way macro-, microeconomic or other types of events can affect financial markets is by creating positive momentum. If the recent developments are a reason for market participants to be optimistic about the particular asset or the entire market, they would be willing to buy and capture the looming bullish trend. Market booms are always caused by events that investors consider favorable for their positions.
If some events aren’t considered too important, they might not trigger any reaction from market participants. We refer to situations, where the market doesn’t move or makes only sideways moves, as stagnation. Periods of stagnation indicate that there are no developments worthy of either a positive or a negative market reaction.
How to Prepare for the Impact of Events on Financial Markets
Trading mastery lies in the ability to adequately interpret the effect of a particular event on the assets of interest. Furthermore, it requires careful consideration of the timing of this reaction so that the trader isn’t surprised unpleasantly.
There are two possible ways for traders to prepare for the impact of a particular event on their portfolio – either ex-parte (before it happens) or post-factum (after it happens).
Market participants get more certainty about the potential response of the market to a particular event if it has been repeated in the past. The more time it has occurred before, the more valid the data is. For example, interest rate changes have happened hundreds, if not thousands, of times before. We have enough behavioral patterns following central banks’ announcements on record to predict what might happen after the next one. This also means our prediction will be pretty accurate.
Most of the time, traders would be looking at economic calendars or earning announcements to see what lies ahead. Then, they will make sure to interpret how these events will affect their portfolios and act accordingly.
On the other hand, there are situations that have never been seen before, or at least the representative sample isn’t as extensive enough to make adequate judgments. Events that hit hard and suddenly, leaving no time for reaction (e.g., flash crashes), also fall in that category. In situations like these, traders usually base their decisions on their expertise and common understanding of market mechanics. In that sense, the ability to draw parallels, map out the interconnectedness, and forecast the potential effect of a particular event is detrimental to success. That is why the more experienced the trader is, the greater the chance to come out of the unpredicted situation unscathed or even profitable.
Examples of Major Historical Events and Their Impact on Financial Markets
History books are full of events that have heavily impacted financial markets and the portfolios of retail and institutional players. From major global crises to isolated market- or asset-specific events, here is a list of some of the most notable ones to help you put things into perspective:
The Great Depression (1929 – 1932)
The Great Depression is the largest bear market in history. During the 34 months it lasted, the market fell 86.1%. Furthermore, it couldn’t regain its pre-crisis levels until 1954.
Several factors led to the Great Depression. Among them is the lack of fiscal spending and the reduction in the money supply. The combination of those factors triggered a banking crisis and a shrinkage in credit supply, causing a series of corporate bankruptcies.
The crisis affected the entire world, causing a 15% drop in global GDP (in comparison, the crisis of 2008 resulted in a 1% drop in the GDP). Personal income, profits, and prices dropped by over 50% worldwide. The US unemployment hit 23%, while it exceeded 33% in other countries.
The Oil Crisis of 1973 (October 1973)
In October 1973, the Organization of Arab Petroleum Exporting Countries members triggered the first major oil crisis in history by announcing an embargo on countries that had supported Israel during its war with Saudi Arabia (the Ramadan War). Among those countries were the US, Japan, the UK, the Netherlands, and Canada.
As a result of the embargo, the price of oil jumped 300% in just a year. In the US, the prices went even higher. In addition, the embargo also had several short- and long-term effects on global politics and the economy. Western central banks decided to sharply cut interest rates to encourage growth. The embargo also reshaped the automobile industry in a way that later on made it more resilient.
The Dot-Com Bubble (2000 – 2002)
The burst of the Dot-Com bubble is an example of corporate valuations gone wrong. In the 90s, investors were hyping and heavily investing in the US tech sector. NASDAQ experienced a 518% boom in the period 1990 – 1998, followed by a 29% decrease in 1998 and another 255% rise in the years up to 2000. Close to 40% of all venture capital investments went to the tech industry. Investors started tipping every company to become the next Microsoft. Even small, hardly profitable companies had market valuations exceeding those of established global corporations.
However, by the end of 2001, most of these companies had gone bust. The crash was so severe that it made tech giants like Cisco, Intel, and Oracle lose over 80% of their value. The NASDAQ index took over 15 years to regain its pre-crisis levels.
The 9/11 Terrorist Attacks (September 11, 2001)
The terrorist attack led to a sharp stock market plunge. Collectively, the US markets lost $1.4 trillion in value. To prevent panic selling, the New York Stock Exchange and NASDAQ remained closed on September 11, 2001. However, once the markets opened, they immediately started losing value. Throughout the week, the Dow Jones Industrial Average had lost 14%. Meanwhile, the S&P 500 and NASDAQ losses were 11.6% and 16%, respectively.
At the same time, commodities like gold and oil rallied.
Among the most affected industries were airlines and insurance. The former couldn’t operate for days. Meanwhile, the latter had to cover a massive amount of insurance claims all at once. Doing so raised the default risk in the industry.
The terrorist attack also had indirect effects on the US economy. It triggered wars in Iraq and Afghanistan which went on for years and cost trillions of taxpayer money.
The COVID-19 Pandemic (March 11, 2020 – Ongoing)
While the first reported case dates back to November 2019, the topic first made the global headlines a month later. However, right after the first cases in Europe were reported at the end of January 2020, investors started to acknowledge it. Yet, the markets only reacted in March, when the situation was declared a global pandemic. This was all reflected in the S&P 500 performance.
The period November 2019 to February 2020 saw the S&P 500 gain 10.7%. The following 30 days saw it tumble over 33%.
The ongoing pandemic and the necessary lockdowns have destroyed many businesses globally and negatively impacted industries like tourism, hospitality, airlines, and more. As a result, demand for electricity and fuel (oil, gas, etc.) decreased notably, bringing their price down. On the other hand, tech stocks soared, and online shopping marked its most considerable growth in history. The impact of the COVID-19 pandemic isn’t a finished story. It continues and will likely bring us new trends in the near future.
Events affecting global financial markets vary in terms of scale and nature. However, what is guaranteed is that the consequences of most of them are no longer isolated to one sector. The interconnectedness of the global financial ecosystem has brought us to a situation where most events have a cross-industry impact. That is why it is essential to understand the intricacies of the different market events and how they can impact your portfolio. Fortunately or not, the trader of today has to be more informed, skilled, and prepared. The risk universe has never been as expansive as it is nowadays.
How do events impact financial markets?
Based on their nature, severity, and timing, different events and news can lead to market booms or busts. In some situations, markets can remain indifferent to an event, even though it might seem potentially very important. Based on the event and its estimated impact on the portfolio, traders can decide to buy, sell, hedge, or remain passive.
What are the events that have the largest impact on financial markets?
The events that have the most significant impact on financial markets are typically macroeconomic or microeconomic in nature. Those include all types of economic performance forecasts and announcements on a national, regional, local, or corporate level. Other events that can affect global markets can be wars, natural disasters, geopolitical conflicts, and more.
Why should you understand the impact of major events on financial markets?
You should be familiar with the potential impact of big events on financial markets so that you are well-prepared to protect and grow your portfolio. That way, you can shape a proper risk management strategy and plan the steps to take in different market scenarios. You can take measures either before or after the event materializes.
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