ANDREW BUSCH translates world events into trading opportunites.
Throughout world history, infectious diseases, environmental catastrophes and political turmoil have roiled economies. These events disrupt financial markets, yet few people have figured out how to locate the trading opportunities these events can generate - until now.
In his book, World Event Trading, Andrew Busch, global foreign exchange strategist with Bank of Montreal in Chicago, shows how to make sense of these events and find the common patterns that make it possible to devise trading strategies based on anticipation of an event rather than reaction after the fact.
"Preparation is the key," Busch says. "When you have analyzed earlier such events and have a strategy in place for responding, you can avoid being reactive and approach whatever happens with a level head. Having prepared, you can go to your list of possible trades and reap the benefits."
Busch studied events as far back as the bubonic plague of the 1300s and as recent as the Severe Acute Respiratory Syndrome (SARS) crisis of 2002-2003. He also looked at environmental catastrophes, including hurricanes, earthquakes, tsunamis and global warming. On the political front, Busch examined terrorism, changes in government, scandals and shortterm war.
Common problems
Even within one category, each event is different in
terms of timing, duration, severity, and human and
financial cost. What are less obvious, Busch says, are
the common threads from seemingly disparate events.
"Looking at all of these kinds of events, past and present, you can see three consistent themes across decades," Busch says. "The population is already under duress. People have imperfect information about the disease or event. Governments initially do the wrong thing at the critical time to further accelerate the outbreak or compound the economic problems."
Busch points to the bubonic plague that hit Europe in the grip of severe famine and financial crisis. The more recent 'mad cow disease' outbreak in England emerged at a time when its government was in a state of flux.
The lack of information concerning hurricanes, earthquakes, and tsunamis stems partly from bureaucratic bumbling, but more from the impossibility of predicting these events with any certainty. Yet there are patterns. Hurricanes have a season. While no one can forecast how many severe storms will hit the U.S. Gulf Coast, traders know that when a severe hurricane hits the energy producing regions along the coast, its market effect will be brief - two to three months, according to Busch. And such events will primarily hit energy, lumber and the stock market.
Trading these events can take two forms. The major stock indexes tend to hit lows or near lows when big hurricanes threaten the Gulf Coast. Shortly after the hurricane passes, they tend to rally. Bond yields often follow a similar pattern. So, knowing a force 3, 4, or 5 hurricane is heading for landfall along the Gulf Coast, traders could sell E-mini S&P 500 futures or buy 10-year T-note futures, Busch says. When the hurricane hits and the stock market drops, it is time to unwind - quickly. Similarly, when Treasury note prices peak, traders should be ready to unwind.
The other way to trade such an event is to wait for the hurricane to push the stock market down or forge a spike in T-notes and buy E-mini S&P 500 futures or sell T-note futures.
"Traders who have an awareness of how these things develop can devise a game-plan well ahead of the event," Busch says. "This way, as they see it develop, they can go with the flow of the event. These things seldom last long, so traders have to be ready to move decisively."
Keeping in context
One thing Busch stresses is the need to understand the
context in which the event is occurring. Early in the
development of the SARS epidemic, for example, it
became obvious that people who traveled by plane were
spreading the disease. Not surprisingly, airline stocks
took a hit. But the ones most affected were those whose
primary operations were in Asia where the outbreak
originated. Furthermore, this entire episode unfolded
over a roughly eight-month period in 2002 and 2003.
By the time the "all clear" was sounded, the affected market sectors had rebounded. This points to the importance of decisive action for traders. The opportunity will be there, but not for long.
Another important aspect of context involves concurrent events. Busch focuses on the Federal Reserve Bank's fed funds target rate. You might well ask what this has to do with, say, mad cow disease.
"In general, when the Fed is lowering the target rate, this is equity friendly and dollar unfriendly," Busch says. "When the Fed is raising the target rate, this is typically equity unfriendly and dollar friendly. It follows that if the stock market is improving already, a lowering of the fed funds rate will speed the improvement. But, if the Fed is raising rates, this will exacerbate and speed up a bad market."
In his daily work, providing hedging and trading strategies for institutional clients, Busch says the ability to analyze these world events and plan trades based on these analyses has been his biggest advantage over the years in his striving to add value for clients.
He writes in his book that this method of world event trading "is somewhat the antithesis of program or model trading. World event trading... is more nuanced, more difficult, and more exciting."
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