When market experienced sentiment flip flopping back and forth in its behavior Risk-on and risk-off happens. The price behavior responds to and is driven by changes in investor risk tolerance. There is daily headline risk, geopolitical risk and economic risk, not to mention the ongoing political rumor mill. This type of action can take a toll on a trader or investor’s emotions, and can also provide opportunity. But what exactly do “Risk-On” and “Risk-Off” mean?

What is “Risk-On” and “Risk-Off” mean?

During periods when risk is perceived as low, the risk-on risk-off theory states that investors tend to engage in higher-risk investments. When risk is perceived to be high, investors have the tendency to gravitate toward lower-risk investments. In this article We would like to explain in more detail what “risk-on, risk off” (RORO) means and how traders and investors can use the corresponding market developments.

When investor sentiment is optimistic about the economy, geopolitics and industry, riskier assets tend to get pricier. That is known as “Risk-On.” Conversely, when uncertainty or negativity hits the market, investors tend to sell these riskier assets and buy “safer” assets, ones that are typically less vulnerable to a weakening outlook or negative investor confidence. This is “Risk-Off.” Risk-on/risk-off describes how the markets react to events and are guided by changes in investors’ risk tolerance. RORO refers to changes in investment activity in response to global economic patterns. In periods when the risk in the markets is considered low, the risk-on/risk-off theory assumes that investors tend to invest in riskier asset classes. However, if the risk is perceived to be high, then investors tend to base their investment behavior on low-risk investments.

What determine the Risk Tolerance

• Risk-on means that traders and investors are prepared to take risks and they are focused on the return on investment; risk-on asset classes are in demand and there is a strong correlation; in other words, greed is dominating the markets.
• Risk-off means that traders and investors are risk averse and the focus is on preserving capital; risk-off asset classes are in demand and there is a strong correlation; in other words, fear is dominating the markets.

Gold Safe Haven Value

Another interesting point worth mentioning concerning gold is that it is entirely possible to see both equities and gold markets rally side-by-side. When the economic cycle is positive (GDP is rising), stocks generally appreciate while gold falls. Yet, if inflation is rising along with GDP then both gold and stocks can rally, as gold is thought to be a hedge for inflation

Oil

A decline in oil prices generally leads to the US dollar and USD/CAD rallying, as Canada’s economy is heavily tied to the price of oil. As of 2019, it’s the fourth largest oil producer in the world, delivering more than 5.50 million barrels per day. Because of the volume involved, it creates a huge demand for Canadian dollars.

Current Movements has been changed

When central banks cut interest rates into negative territory and unusual monetary policy moves affected the currency markets the market behavior has changed.

The central banks’ comprehensive monetary policy programs (Quantitative Easing) have disrupted risk / risk-taking around the world. To introduce inflation central banks buy their own government bonds in this situation. Markets had to adjust to this new reality, and today we see negative interest rates in many major central banks around the world. The purpose of a negative interest rate environment is to encourage commercial banks to lend more to the real economy, which aims to create jobs and economic growth. As the economy expands, inflation will rise, and as it happens, central banks will return their monetary policies to normal. Until then, markets will adapt to new realities and risk-risk / risk perception will be defined. As a rule, you may remember that there is a risky trade when risky currencies are sold across the board against the Swiss Franc and the Japanese Yen.

Conclusion

Traders can take advantage of competition if they know what to expect from a risk-on/risk-off perspective. This will be very helpful to avoid excessive trade which can be caused by market interactions.