We often hear about
"Risk-on" or "Risk-off" in financial markets, but what do
these expressions mean? Below is the answer!
Reading Time: 5 minutes Financial activity: Trading/Investing Knowledge level: Beginner
Summary
The meaning of "Risk-on"
and "Risk-off"
Some examples of risk-on and risk-off assets
Market Sentiment Indicators
Conclusions
The meaning of "Risk-on" and "Risk-off"
"Risk-on" and
"Risk-off" are terms used to describe changes in investor sentiment
toward market risk in different economic scenarios.
Risk-on: this is an
investment setting in which investors are willing to take more significant
risks to achieve higher returns. During risk-on periods, investors tend to
invest in higher-risk instruments, such as stocks, commodities, and emerging
market currencies.
Risk-off: this is an
investment setting in which investors prioritize preserving their capital by
investing in safer assets such as bonds, cash, and other low-risk securities.
During risk-off periods, investors tend to avoid high-risk assets and favor
low-risk investments that are less likely to lose value.
Investors' attitudes
towards risk can change depending on the market conditions and investors'
perceptions of the economy. For example,
during periods of economic growth and optimism, investors may be more willing
to take risks and invest in higher-risk assets. Conversely, during periods of economic
decline or uncertainty (like wars, pandemics, etc.), investors may be more
risk-averse and prefer to invest in safer assets.
Not all asset classes
carry the same risk, and investors tend to change asset classes depending on
the perceived risk in the markets. For instance, stocks are generally
considered to be riskier assets than bonds.
Some examples of risk-on and risk-off assets
Typical Risk-off assets are investments considered safer and less volatile than other
investments. Some examples of "Risk-off" assets include:
Government Bonds. They
are bonds issued by governments and they are considered to be the safest
investment. In this category, we have the Treasury bonds issued by the U.S.
government or the German “Bund”.
Gold. Gold is
considered a haven asset, especially during economic uncertainty, geopolitical
tensions, or inflation.
Risk-Off Currencies. The
United States Dollar (USD), Japanese Yen (JPY), and Swiss Franc (CHF) are
typical examples. Risk-off currencies are seen as more stable and less
volatile, gaining value when investors seek safety.
These financial
instruments are typically associated with higher-risk investments and perform
well when the market sentiment is optimistic (Risk-on assets):
Stocks. During the
Risk-on time, investors were willing to invest in speculative assets, such as
real estate and technology stocks, to achieve higher returns.
Risk-on Currencies. The
Australian Dollar (AUD), New Zealand Dollar (NZD), Canadian Dollar (CAD), Euro
(EUR), and British Pound (GBP) benefit from increased investor confidence and
higher interest rates in times of economic growth and positive market
conditions.
Cryptocurrencies. Bitcoin
is known for its high level of volatility and lack of regulation, so it is
considered a high-risk, high-reward investment.
Commodities. During
periods when investors perceive economic growth, they buy commodities related
to industrial use such as copper and oil.
Market Sentiment Indicators
What indicators can I
consult to understand what type of period we are in?
The VIX (Volatility Index)
The VIX is a market index that measures the market's expectations for volatility over the coming 30 days. The VIX is used as a contrary market indicator. The VIX attempts to measure the magnitude of price movements of the S&P 500, and the more dramatic the price swings are in the index, the higher the level of volatility, and vice versa. Traders can trade VIX futures, options, and ETFs to hedge or speculate on volatility changes in the index.
So, the risk is Risk-on
if VIX is down, and risk is Risk-off if VIX is up.
The COT (Commitments of
Traders Report).
I have written a post about it: Beginners guide to Commitments of Traders Report (COT) - The most important market sentiment indicator.
Simply read it!
You can also watch some online tools, like this: CNN BUSINESS-Fear and Greed Index.
Conclusions
In summary,
"Risk-on" and "Risk-off" are terms used to describe changes
in investor attitudes toward market risk in different economic scenarios.
During risk-on periods,
investors tend to invest in higher-risk instruments, while during risk-off
periods, investors tend to avoid high-risk assets and favor low-risk.
For these reasons, you
must stay informed (monitor global economic news and financial reports), watch
Central Banks' decisions, analyze market sentiments (using some indicators like
VIX), and practice clever risk management with diversification of invested
assets.
A sincere wish of good
work to all!
Written by F. GRAMOLA
(*).
(*) Member of S.I.A.T.,
the Italian Society of Technical Analysis (member society of I.F.T.A. –
International Federation of Technical Analysts).
Warning
We merely cite our
personal opinions for educational purposes only.
All trademarks are the
property of their respective owners.
Investing and trading
are risky. Don't invest or trade money that you cannot afford to lose.
Initial photo by John McArthur on Unsplash.
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