Elections are one of the few big market events whose date is known well in advance and whose result is not. That combination makes them a classic source of risk. Currencies, government bonds and shares can all move sharply when a result surprises, and even a close race can unsettle prices in the run-up. With Israel voting this week and elections regularly on the calendar around the world, it is worth understanding how markets price the unknown.
What election risk means
Election risk is the possibility that a vote changes the direction of economic policy, government finances or a country’s relationships with the rest of the world in ways investors have not fully priced in. It is not about which party is better. It is about uncertainty, and markets generally dislike uncertainty because it makes future cash flows and interest rates harder to predict.
How markets price it before the vote
Ahead of a vote, traders look at opinion polls, betting and prediction markets, and the policies each side is promising. Options markets are a useful window here. If traders expect a big move around results day, the price of options on the country’s currency rises because people are paying for protection. Our explainer on risk reversals in FX options explains how traders read which direction they fear most.
Investors often reduce their positions before the result, which can make prices drift. If the polls point clearly one way, much of the expected outcome may already be in the price by polling day.
What happens when results land
The biggest moves come from surprises. If a result was expected, markets may barely react. If it was not, the move can be large and fast. The 2016 Brexit referendum is the best-known UK example: sterling fell sharply overnight as results came in, because markets had leaned towards a vote to remain.
The second wave comes from what happens next. In countries with proportional voting, such as Israel, the Netherlands or Germany, no party usually wins outright, so the real outcome depends on weeks of coalition talks. Markets can stay nervous until a government is formed.
Which markets react most
The currency is usually first, because it trades around the clock and reflects views on growth, interest rates and capital flows. Government bonds react to what the result means for borrowing and spending. Our guide to sovereign credit ratings explains why investors care so much about fiscal plans.
Shares react sector by sector. Banks, energy companies and utilities are often sensitive to policy changes on tax and regulation, while exporters may benefit if the currency falls.
Some elections matter well beyond their borders. When a country is involved in a regional conflict, the result can shift expectations for security and, in turn, for oil and other commodities.
How beginners should approach it
The safest approach is to treat results night as a period of higher risk rather than an opportunity to guess the outcome. Spreads can widen, prices can gap and stop orders may fill at worse levels than expected. Our explainer on price gaps in trading covers why. Many experienced traders reduce their size or stay out until the picture is clearer.
For how this week’s vote fits into the wider market picture, this morning’s Morning Market Brief has the latest. If you want to understand how you behave when outcomes are uncertain, the free Samuel & Co Trading Trader Assessment is a sensible next step.
