What Traders Mean By Risk On and Risk Off and Why It Matters
Market Analysis - | 19 Sep 2019
What is RORO (risk on/risk off)?
Traders will nowadays often hear the terms "risk on" and "risk off". They are generally used to describe global market sentiment. When investors feel optimistic about the economic outlook, riskier assets will be in demand, and we could say it is a "risk on" market. However, when investors are worried about the global economy or, for example, think the trade war could cause a recession, they would sell risky assets and buy so-called "safe havens".
What are typical "risk on" instruments?
- Stocks, especially emerging market stocks
- Commodity currencies (AUD, CAD, NZD)
- Emerging market currencies (ZAR, THB, TRY, CLP)
- Commodities (Copper, Oil)
What are typical "risk off" instruments, aka safe havens?
- Precious metals (Gold, Silver)
- Swiss Franc
- Japanese Yen
- G10 Government Bonds (especially US and German Government Bonds)
Of course, correlations will break and it is not as simple as buying stocks and emerging market currencies during good times, and buying Gold and Swiss Francs during the bad times. For example, an economic crisis in South Africa could keep the ZAR under pressure even during “risk on” sentiment or a market intervention by the SNB could bring the Swiss Franc down during a “risk off” market.
What could trigger “risk on” sentiment in global markets?
- Decreasing rate expectations, i.e. traders expecting further monetary policy easing from central banks
- Improving economic outlook
- Improving political conditions (i.e. a political crisis that was resolved)
- A strong corporate earnings season
What could trigger “risk off” sentiment in global markets?
- Recession fears
- Political crisis (i.e. Brexit, geopolitical tensions)
- Panic in the Markets (i.e. a flash crash could weigh on sentiment for longer than expected)
- A poor corporate earnings seasons
Why does this matter?
Tracking sentiment can help traders filter trades. For example, even if a system triggers a buy signal in AUD/JPY, buying this currency pair in a risk-off market where demand for the Japanese Yen is strong might not be the best idea. Even if traders do not want to use this for filtering trades, it cannot hurt to be aware of the general feeling in the market.
Recent example of a Risk-On Market
During August, market sentiment started to improve as tensions between the US and China eased slightly. Furthermore, investors were expecting more easing from central banks. The S&P 500 rallied along with European indices, and Japanese Yen declined as demand for safe havens waned.
The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.
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