Who do you think will win the US election?
Why will he/she win?
I have a low degree of confidence in my guess on who will become US president. It’s always a trap for traders to translate their own political opinion into an assumption about an election result. I’m not living in the US or speaking to many Americans, so I am basing my answer on the polls and betting markets. At this stage these are pointing to a Clinton victory, but as Brexit proves, these indicators are far from infallible.
Trading is always about relating risk to reward and the US election will be no different. The best opportunities with major events can often be contrarian ones where markets are pretty much priced for one particular outcome.
So you’ve got as far as deciding that the market will view a Trump victory as a ‘risk off’ event, and a Clinton victory as less negative.
So, how will you go about translating this view into a trading opportunity with acceptable risk? There are two things I think traders can usefully do leading into big market events.
The first is to think and plan in advance for how markets might react. Markets will not always behave as you expect of course, but you don’t have to trade at this moment. There will always be plenty of other opportunities, after all. However, events move markets and if the market response does start to pan out as you anticipate, it can be a significant opportunity.
The second thing traders should always do is to use appropriate risk management. This is essential to trading success but, if anything, it’s even more important when trading around big events where volatility can be high.
Price and the risk-reward relationship
Trading is always about relating risk to reward and the US election will be no different. The best opportunities with major events can often be contrarian ones where markets are pretty much priced for one particular outcome. This can mean very large moves in favour of contrarian positions when the outcome is unexpected (think Brexit). Moves tend to be smaller if things pan out as expected.
Sometimes there can even be ‘buy the rumour; sell the fact’ outcomes, where profit-takers end up pushing the market in the contrarian’s favour even when the result comes in as expected. It’s not so much about what you think the result will be; more about how you think markets will react to different outcomes.
Volatility and establishing the facts
With economic releases, the facts tend to be known instantaneously. With an election result, things can be uncertain for some time as the counting unfolds. Pundits often spend a lot of time saying it’s too early to make a call and then move quickly in deciding it’s all over. Markets will follow suit. At other times, the result can be uncertain for a long time, creating market volatility. Think in advance about how you will handle either of these circumstances as a trader. The US presidential election often comes down to a couple of the large swing states like Florida; North Carolina and Ohio. It might pay to focus your attention on the outcomes for swing states like these.
Don’t forget the US Senate
How risky or otherwise markets expect a new president to be is partly a function of how much control they have. The most negative result from a market risk point of view might be if Donald Trump becomes president and the Republicans win the Senate. That’s likely to enhance Mr Trump’s ability to get things done.
Candidates’ policies crucial
If current thinking is correct, markets will be concerned about Mr Trump’s perceived inconsistency and economic policies, which potentially threaten the established economic order. This might be seen as threatening growth prospects and the interests of existing large companies. Trade protection policies might be an example.
However, markets may not move to a full ‘risk off’ position until they get a sense of exactly what the new administration’s policies will look like and whether they will be passed. That could take a long time. This scenario might produce a recovery from an initial Trump sell-off, or the opportunity to fade a Clinton rally. It could be a good idea to keep a close eye on chart levels.
Using risk management
It’s always important to use stop-losses and to go into a trade where the potential profit makes sense in relation to the loss you will make if your stop-loss is triggered.
When trading these types of event, it helps to have a clear idea of the timeframe you’re going to trade. Long-term traders have a much larger profit potential. They can afford to have strategies that set stop-losses beyond the likely noise levels implied by false starts or a change of mind about the likely result on election day.
Another sensible risk-management strategy is to allow for the worst imaginable scenario. Plan for the possibility that markets will gap past your stop level. That means the trade would be executed at a worse level than you have stipulated, unless you are using guaranteed stops.
It’s also sensible to make sure your positions are kept to a size that means even the worst outcome would result in a loss that is a manageable percentage of your trading capital. Trading hugely significant events like the US election can be very rewarding, but controlling losses is essential to long-term trading success.
CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.