*Learn what is meant by the terms “Risk Off” and “Risk On” and how the markets move when risk switches*
This is going to be a fairly short and simple blog post to explain what is meant when those in the finance industry talk of investors/traders being risk off and risk on. When people speak of the markets being risk off or risk on, they are talking about the overall trading sentiment of those participating in the financial markets. It is describing their appetite of risk and this therefore effects certain instruments in various ways.
Risk Off – Investor appetites for risk is reducing and they are taking cash out of riskier investments and moving in to safer investments.
Risk On – Investor appetites for risk is increasing and they are beginning to put more cash in to riskier investments.
When I say cash, I am talking about investible capital. The term investors can mean anyone from retail traders to hedge funds and investment banks.
So now you know what is meant when you hear the terms risk off and risk on mentioned in the news and online, but how does investor risk sentiment move the markets?
Easy… if risk appetite increases (risk on) then the value of safer, lower interest products decreases and the value of riskier investments increases. The opposite occurs if investor risk appetite decreases.
What investments/products are considered to be safer?
- Gold – The most popular and well known safe haven is the shiny yellow metal. It has been around since the beginning of time and according to research, around 40% of Gold stock above ground is used for investment purposes. Gold is considered a safer investment because it has historically maintained its value (and generally increased) over a very long period of time.
- Japanese Yen FX Currency – Most people just assume the Yen as a safe haven currency to flock to purely because it has always strengthened in times of risk aversion and therefore there is no need to question why. The main reason for Yen appreciating in times of economic uncertainty is that money tends to flock home. And the Japanese are one of the biggest holders off foreign assets vs Japanese assets help by foreign investors. Therefore when they “flock home” the flow of cash back in to Japan is far greater than the outflows and thus the currency strengthens.
- Fixed Income – FI is a type of security that pays investors fixed interest until its matured. Naturally this is a lot safer than investments that do not pay interest and rely on just their value increasing. In times of global uncertainty and economic struggles, many prefer to just take a safe lower interest payment on their investments and therefore buy in to fixed income. This then drives up price.
What investments/products are considered to be riskier?
- Foreign Emerging Markets – Emerging markets are considered high risk for a number of reasons. They tend to be less liquid than developed economies so stocks can be particularly volatile and transactions can be difficult. Emerging markets are normally a lot more relaxed on business laws and trading restrictions so manipulation of the markets is common. These both raise the risks of investing.
- Australian Dollar FX Currency – The Australian dollar is seen as a risk asset because it is a high yielding currency. When there is a risk on sentiment, investors tend to take their capital and speculate in the stock markets and FX markets.
- High Yield Bonds – The general consensus in a risk off market is that investors begin to sell off their higher yielding investments. High yield paying bonds tend to be from governments of riskier countries or businesses deemed a higher risk and that is why investors are paid a higher yield to hold the bonds.
So there you have it, the definitions and reality of what is meant by a risk off and risk on market sentiment. Risk aversion is something that you should all learn to understand and knowing how it moves the global markets is something all traders should look to do.
The simple rule is:
Risk Off = Safer investments go up in value.
Risk On = Safer investments go down in value.
I hope you enjoyed this short read and have a great week. Please remember to LIKE, SHARE and FOLLOW my blog to stay up to date with the latest blog posts.
DISCLAIMER: None of the information posted on this site is to be considered investment/financial advice. Trading is high risk and you should only trade with money you can afford to lose.