Trading the election outcome

This November’s U.S. Presidential election will affect currency markets, and the challenge for the forex trader is to select the best strategy for trading it.

This November’s U.S. Presidential election will affect currency markets, and the challenge for the forex trader is to select the best strategy for trading it. It is important to keep two dimensions of analysis in mind: time frame and volatility. 

There is a short- versus longer-term trading strategy. A near-term trading strategy targets a pre-election shift in expectations and any surprise on election night. 

A Trump win — or shift in general expectations — will generate greater volatility as uncertainty will surface. A Trump presidency will affect trade agreements, China relations, Middle East conflicts and fiscal policy. 

A Clinton victory is likely to be less disruptive as it would be essentially a continuation of the status quo. 

The price reaction to the election results is also a function of the level of surprise. A tight race right before the election will be the impetus for a stronger post-election response. In this case, the forex trader should look to the U.S. dollar/Japanese yen currency pair. The results in the early evening will coincide with the active trading in the Japanese markets. The yen usually strengthens when there is a risk-off market condition and weakens against the dollar in a risk-on market. In short, on election night, watch the USD/JPY closely and “buy” USD/JPY with a Clinton win or “sell” USD/JPY with a Trump win. In either case, it is a scalping scenario with potential whipsaws. 

There are other ways to trade the election. IG Markets, based in London offers a direct binary on the election result. A bet on a Clinton win on Sept. 7 costs 70, whereas a Trump win costs 32. Both paying 100 to the winner. Beyond election night, one strategy available in the United States is to trade an end-of-week expiration on a binary underlying market. The North American Derivatives Exchange (Nadex) offers end-of-week binary options on a wide variety of underlying markets. Placing the trade on Monday Nov. 7 for an end-of-week expiration on the S&P 500 (US500) or on any currency pair enables one to play a risk-on or risk-off result. Binaries settle at either 0 or 100. Therefore, buying an out-of-the-money binary strike at a 40 ask price or selling a binary at 60 will enable a play on a bearish or bullish reaction with a 50% return on the risk. Not bad for one week.

Let’s consider a longer-term strategy. In the event of a risk-off post-election Trump win, money will likely go into safe-haven baskets. In this scenario, the yen will likely strengthen and remain strong as it usually does in reaction to weak U.S. markets. Also, a Trump win may result in a nervous Shanghai market. Traders should watch the Shanghai Index as reaction to a Trump victory may cause sell-offs that can cascade around the world.
 
The Mexican Peso (MXN/USD) is likely to experience volatility as well on a Trump win.

Beyond this macro view, the forex trader needs to understand that the U.S. election will not be a departure from fundamental forces that are already at work, which are far more important. First, no matter who wins, the most important factor affecting currency markets will be the Federal Open Market Committee rate expectations. If the Fed raises rates, the central directional tendency will be for the U.S. dollar to strengthen. Expectations on increasing interest rates are more psychological than fundamental because the critical factor is the rate of inflation and the expected rate of inflation. However, the Fed is at the point where they need to act. 

Traders should not ignore the importance of the business cycle. As the recovery grows longer, the probability that the next President will face a recession increases. This cyclical fundamental force is more important than who gets elected. 

What does this tell us about the relevance of the U.S. elections? If the world is in a phase of secular stagnation, currencies will be reacting to this major paradigm and not to who is President of the United States. Post-November, the fundamental forces that have generated low inflation, low interest rates and low productivity remain the main shapers of the direction of currency prices.

About the Author

Abe Cofnas is author of “Sentiment Indicators” and “Trading Binary Options: Strategies and Tactics” (Bloomberg Press). He is editor of binarydimensions.com newsletter and can be reached at abecofnas@gmail.com.