Reading Risk On and Off

Reading Risk ‘OFF’ or Risk ’ON’ Sentiment

Rumors tend to spread daily and stock markets move accordingly, obviously depending on how reliable the source is. Traders have to deal with this affect of up and down constantly based on the “Risk On” – “Risk Off” Sentiment.

To read Risk Sentiment can be as easy as tagging on to the direction of the Stock Market.

One way to gauge an underlying trend in the market is through the risk appetite of investors. The benefit of understanding the mood of the market is it allows you to align your trades in the direction of the market sentiment.

“Risk On” is when you see the  stock market increase significantly. “Risk On” can best be desctibed as when investors feel good about the market and future prospects of the econome. Experienced traders will then take their capital and speculate in the stock market and purchase high yielding instruments. When this happens the stock market usually increases in value, with high yielding currencies which are currently the Australian Dollar (AUD) and New Zealand Dollar (NZD).

Low yielding instruments at this time generally gain less on a relative basis or even lose thier value. Traders during this time tend to sell Lower yield currencies to free up capital to purchase high yield currency. The selling of low yield currencies whilst buying high yield currencies is known as the ‘Carry Trade'. So an effect of a risk “on” sentiment is an increase in the stock market and demand for high yielding currencies. The Carry Trade strategy tends to perform well as a result of this, which we will talk more about later on, including strategies.

When the stock market falls, this is labeled or known as “risk off”. This means traders and those keen on investment that they are averse to risk. And this means they want to avoid purchasing risky instruments. What usually happens here is that traders pull out their money from stocks and also sell their high yield currency positions. In a “risk off” market environment, the strategy of carry trade will not work. Even though traders can gain daily dividend, the movement of the exchange rates is so adverse that is wipes out any interest gained. Safer currencies such as the US Dollar and Japanese Yen are better options in a “risk off” environment.

Fore more on reading risk, please continue through our forex training.

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