Prior to 1996, most in the agricultural markets didn't spend too much time worrying about what farmers fed their cattle. Prior to 2001, most in the financial markets didn't spend much time analyzing U.S. foreign policy. Prior to 2005, most in the financial markets didn't spend much time analyzing weather patterns. Suffice it to say, things have changed as infectious diseases, terrorist activities, and hurricanes have all made their presence felt in ways that shocked the world and financial markets. The impact from these events has been concentrated into a shorter time frame due to vastly improved means of communication across the planet. Therefore, the effect is more pronounced and sharp.
There are consistent characteristics that events have over time. You can begin to build a strategy or portfolio and be ready to take advantage of these events should they start to appear. Of course, no new event will be exactly the same as the previous event, nor will the exact timing be the same. This means that the trader needs to be flexible and creative in figuring out what area will be impacted and when.
This concept is somewhat the antithesis of program or model trading. World event trading (WET) requires an intimate knowledge of numbers and statistics, but not as the sole determinant for making money. This is more nuanced, more difficult, and more exciting. The results can be spectacular, as the events can generate extreme price movement and opportunities. These are the famous “three-tailed” or three standard deviation events that can destroy model traders who don't have strong risk management programs. To the uneducated, they seem to appear out of nowhere to disrupt trading.
As an example, look at what happened to Pacific Ethanol, Inc. (PEIX) after President Bush mentioned cellulosic ethanol in his State of the Union address in 2006. At first, everyone thought he just mispronounced something about energy. Figure 1 shows the jump in price and the sustained upward movement for this ethanol producer. This seemed to be a total surprise until one considered the desire by politicians to reduce the U.S. dependence on foreign oil and the impact of hurricanes on oil and gas production. What better way than to encourage the corn belt to become the Saudi Arabia of ethanol? It's interesting to note that Bill Gates' Cascade Investment LLC said in November 2005 that it planned to boost its stake in the Fresno, California, company to 27 percent.
Figure 1: Pacific Ethanol, Inc. (PEIX)
This is one of the many reasons why we in the financial markets monitor what the president says in the State of the Union address, whether it's “cellulosic ethanol” or the “axis of evil.” These are pieces of the political puzzle for the WET trader.
In the foreign exchange market, you need to take advantage of every opportunity, every edge you can to gain advantage over the market. Inefficiencies in the financial markets don't occur with regularity. Model trading quickly eliminates many of these. There are so many PhDs of statistics and math from Beijing to Bucharest analyzing different quantitative angles to trading that inefficiencies exist for only a short period of time. However, it's almost impossible to mathematically represent SARS or Hurricane Katrina. This is why you need an understanding of how an event develops and how to capitalize on the situation when it occurs. WET requires broader knowledge of the planet and how it has functioned during these events over time to generate outsized profits.