Forex Blog: Currency Trading News & Analysis.

June 21st 2007

How Does Terrorism Affect Your Trading?

Most American traders know that a majority of stock market investments have become global over the past quarter century. Even homegrown companies have expanded with overseas offices or, at the minimum, overseas clients have come on board through the Internet. Currency traders aren’t immune to global trading, as the Forex market has opened to any interested trader with money to invest. While investors can look forward to portfolio growth with market expansions, they can also begin to measure how terrorism has affected their trades since 9/11.

The events on 11 September 2001 seem to provide the baseline for many analysts on how terrorism can affect trading. The day before the Twin Towers fell, the Dow Jones Industrial Average (DJIA) closed at $9,605.51. One week later, when the markets reopened on September 17, 2001, the DIJA hit an intraday low of $8,755.46 and the market didn’t recover for about another month. But, terrorist attacks – even the threat of an attack – can affect any market beyond Wall Street. Forex is especially susceptible to terrorism, since many targets focus on financial institutions or on major industries that represent wealthier countries.

According to one study [PDF] conducted by Ohio State University, exchanges, banks, and oil companies aren’t the only facilities that terrorists target. This study reveals that 75 terrorist-related attacks between 1995 and 2002 were focused on publicly traded firms and that the average loss per firm per attack was $401 million in market capitalization.

The Forex market has suffered from terrorism as well. When U.K. police foiled a plot to blow up twelve planes flying between Britain and the U.S. in August 2006, the
GBP and EUR fell on the news. In January that year, the U.S. dollar fell when Arabic television station Al-Jazeera broadcast an audio tape in which Al-Qaeda chief Osama Bin Laden warned that new attacks are being prepared on the US. Recently, at the end of May this year, approximately 67 foreign currency dealers were kidnapped and tortured in Zimbabwe. The police had accused them of fueling a parallel market that has seen the Zimbabwe dollar slide to bottom levels with one America dollar fetching over Z$50,000 on the black market and $250 on the official Forex market.

The impact created by terrorism differs according to the home country of the target and the country where the incident occurred (or was foiled). Attacks in wealthier and more democratic countries result in larger negative share price reactions, according to the Ohio State University report. And, human capital losses such as executive kidnappings result in larger negative price reactions than bombings that affect public populations and buildings. The investing population seems to have become somewhat immune to the latter incidents.

When such news is directly connected to market volatility, how can the trader respond to protect his investments? The solutions often depend upon whether the individual is a long-term investor or a trader who tries to anticipate market moves on a second-by-second basis.

Long-Term vs. Day Trade Investors

The long-term investor usually doesn’t need or want to check his portfolio every minute, as that investor views his holdings as business partnerships. Tough times and even tougher news will happen, as no investment is immune from problems. But, if the long-term investor diversifies his portfolio, he can ride through bad news with some confidence. In fact, those down times often represent a reason for this investor to accumulate.

The long-term investor often doesn’t react as quickly to bad news as does the day trader, and he may even ride out the ‘storm’ if the event isn’t an Enron-type disaster. This reaction is based upon a fundamental basis to investing, where the investor relies more on that company’s net worth and future growth possibilities. The day trader, on the other hand, often relies on technical analysis that responds to information that arrives by the second.

Despite these differences, many savvy long-term investors (and day traders) realize that many other investors react emotionally to bad news, and often the window to respond to that negative reaction is short-lived. The day trader might want to react instantly to take advantage of the situation, but the long-term investor may not react at all, other than to keep an eye on the situation to see how the market responds to the situation over time.

With that said, terrorism has created a new environment that has put all investors on alert. To examine how some markets react to terrorism, I’ve leaned on an Investopedia article where they examined how terrorism affected four industries: oil and gas, airlines, auto, and exchange and bank stocks. Some of their material, however, is outdated, so I’ve included insights from current conditions to show how these markets have changed within the past few years. Additionally, I’ve sprinkled the following commentaries with information on why Forex investors might take note about changes in these industries.

Oil and Gas

A 2004 Washington Post article warned that energy experts predicted a continued rise in gas and oil prices after foreigners were attacked in Saudi Arabia. At that time, U.S. crude oil futures prices increased by nearly $2.50 a barrel to close at a record $42.33 on the New York Mercantile Exchange. Additionally, gasoline futures jumped six cents per gallon. Crude oil futures in London rose by a similar amount. As of this writing three years after that event, crude oil futures stand at $68.94 per barrel.

Hindsight is always 20/20, but the long-term investor would look at the difference in the prices between 2004 and 2007 and realize that crude oil futures have increased by close to 30% per year (although this past year has been basically flat…). While crude oil futures took a $15.00 hit this morning, the long-term investor would shrug that drop off as a temporary glitch, one that comes amid caution that a U.S. fuel supplies report due later in the current session will show increases in oil product inventories but a drop in crude oil stocks.

Part of this consistent rise in price arrives on the heels of the laws of supply and demand. Demand will continue to push prices up, but terrorism adds a special twist that focuses many investors’ attention to the MidEast. In reality, supplies are generated worldwide. A drop in Iraqi supplies shouldn’t create a huge dent in worldwide supply, but it will continue to create volatility when news about interruptions surfaces.

In the long run, anyone who goes short on crude oil futures would be considered either a day trader who can pull out in an instant or simply insane. The Iraqi War, increased tensions among all other countries in the MidEast, further hostility from Venezuela, and opposition to home-grown drilling will continue to buoy this commodity until a viable alternative comes to light. No, it’s not ethanol – at least not in this decade – as otherwise the price of gas and oil would drop precipitously as demand trends change dramatically.

Forex traders might take note to follow oil and gas activity, as many times currency is intertwined with this industry. For instance, the Canadian dollar typically responds well to higher oil prices, and political tension in the Middle East and concerns over gasoline stocks in the US can tend to support this trend. An active hurricane season in the Gulf of Mexico can add to this support. And, a few terrorist threats focused on corporate oil executives should make any trader nervous about shorting the Canadian dollar.

Airlines

High oil prices often spill over into other industries, such as airlines and automotive. The airline industry also suffers a double whammy from the fact that this means of transportation has been favored for terrorist acts in the past. While consumers viewed airlines as unsafe shortly after 9/11, and as the price of jet fuel continues to rise, airlines have had to drop back and regroup.

As a result, many airlines have come forward as contenders in the stock market once again, but not without some continued problems. This upsurge comes six years after 9/11 – a long time for any investor to wait, even long-term investors. Expect more mergers, continued efforts to reduce capacity, and an increase in the use of materials and processes that make aging fleets more fuel-efficient. Add surcharges that customers pay for checked baggage and other services to help compete against lower fares offered by upstarts, and rising costs for maintaining an airline fleet might be mitigated.

Even while airlines seemed to be stabilizing, it would only take one terrorist incident to shake that market about 7.0 on the Richter scale. The resultant tidal wave could eliminate some carriers from the market totally. If you use the findings from Ohio State University to understand how another terrorist airline attack could affect Forex markets, you can look at currencies to fall in countries where the flight begins and where it was supposed to end. You might add another currency if that plane ends up in a country other than one scheduled on that flight’s itinerary.

Auto Industry

The automotive industry is in a shambles, but only if you look at it from the American perspective. This is another industry affected by oil and gas prices, and the trends to alternative fuel sources have met resistance from both manufacturers and consumers. Additionally, private equity and the upcoming labor negotiations this fall could make prices shudder even more. But, SUV and Pickup sales – some of the most profitable products for Detroit in the past – are declining thanks to gas prices. In response, Toyota has entered the American market with gusto.

This industry will change so dramatically over the next two decades that it’s impossible to speculate where to go or what to do on a long-term basis. Short-term trends, however, will focus on mergers, buy-outs, and shutdowns of what seem to be perfectly functional operations. China has also emerged as a leader in automotive manufacturing and has become a factor to consider. But, while this industry will be swayed by the money, it isn’t powerful enough to affect currencies. Car bombs are so much part of the daily news that the make of the car used for an attack doesn’t seem important anymore to the average person.

If you invest in Toyota, you might watch for online hysteria about how terrorists seem to prefer this make of automobile over any other for car bomb attacks. If fear overrides common sense in the future, Toyota could face limits or a ban in the U.S. (which means NASCAR will need to change a few things…). This is just one example of how emotions could affect investments.

Exchanges and Banks

This industry is ripe for volatility as the American dollar continues to drop and as other countries drop the American dollar. Sometimes it seems that other currencies appear strong in comparison, especially when a weak dollar challenges U.S. power. But, strength is measured by day-to-day activities, monthly and quarterly reports, and commodities. While the Ohio State University report indicates that investors rarely respond to public bombings, another attack on market exchanges or banks and their infrastructures could cripple global markets.

With that said, the investor needs to consider that many exchanges and banks operate online as well as through brick-and-mortar facilities. The possibility of an online attack, or "cyber-terrorism," aimed at shutting down company databases and IT infrastructures is a real possibility. Even more devastating would be attacks on regional infrastructure that would limit access to online markets and banks across a broad area. Even if you aren’t affected directly by such an act, you can expect negative reactions that force prices down like a brick dropped from the Tower of Pisa. And, until that infrastructure is repaired, you can expect prices to rise like a feather.

Ever see a feather rise? It takes a strong updraft…

What To Do?

As the Investopedia article indicates, one of the best ways to protect yourself against negative reactions to terrorism is to avoid investing all your assets into vulnerable targets and to diversify your investments. Learn how to set stop-losses if you’re a day trader, as they can protect you against a sharp drop on news. But you might think long and hard about stop-losses if you’re a long-term investor. Terrorism events can equate to short-term volatility that may cost you more in the long run. It would be a shame to loose some long-term investment profits to bad news if that news is based upon a false alarm. Those investments could bounce back sharply and create a situation that will cost you unnecessary brokerage fees as well as any interest earned in the past.

But, while you can avoid risk by investing in software companies that protect Internet infrastructure, nothing will protect against a terrorist who cuts a cable that supplies Internet service to an entire region. And, while you can invest in defense stocks that respond well to fear and terrorism, you might choose those investments with an eye to how well those companies would do outside that environment. Environments often change with politics, and American politics are in flux.

Several ways to avoid high risk in currency trading are to avoid day trading in a volatile atmosphere and to avoid trading currencies from countries where volatility is the norm. Day trading is especially susceptible to cyber-terrorism, whereas some long-term investors might not blink if their Internet connection is lost for a few days. While no one can predict when or where a terrorist act will occur, the long-term investor might find the gumption to ride out a negative response to a threat or an actual event. It helps, however, if that investor has done his research and understands how investments respond historically to previous terrorist events.

If anything can be considered positive about random acts of violence, it’s that investors now have access to histories that can help define future market movements. The ability to measure past activity to future possibilities is an advantage, but the intelligent investor — whether short- or long-term — realizes that there’s no safety net in today’s trading environment. Staying informed, perhaps, is the only way to shield profits from losses that occur from terrorism.

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Posted by Adam Kritzer | in Features | No Comments »

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