Why Learn About Risk-On Trading?

Forex traders may benefit from learning about risk-on trading, as being aware of such strategies could help them more efficiently understand market shifts. Some investors believe that the broader asset markets, including those devoted to currencies, revolve around shifts in overall sentiment and how these fluctuations motivate investors to buy certain securities instead of others.

Key Role Of News

Many believe that the release of news, and how his information impacts traders, plays a crucial role in the functioning of the global asset markets.

The basic idea behind this theory is that if investors receive information that makes them more optimistic about economic conditions, they will be more willing to obtain exposure to securities that are riskier.1)Retrieved 13 January 2016 http://lexicon.ft.com/Term?term=risk-on,-risk-off However, it also provides greater chances of manifesting compelling returns. In other words, their risk tolerance will increase, which may motivate them to accept the risks associated with specific assets. Under such circumstances, they may opt to invest in higher yielding assets.

For example, if market participants receive news that a quarterly U.S. GDP report surpassed expectations, this information may make them more optimistic about business conditions. This could prompt them to snap up emerging-market currencies, such as the Brazilian real, based on their belief these currencies will produce stronger returns than safer alternatives.

Duration Of Trends

While some investors rely heavily on trends in the global asset markets in their attempts to produce profitable trades, they should keep in mind that risk-on sentiment could last for as long as years and as short as minutes. During the 1990s, the U.S. stock market rose for more than nine years before changing direction in 2000.2)Retrieved 11 January 2016 http://www.forbes.com/sites/sharding/2014/12/05/are-we-in-another-1990s-style-super-bull-market/ However, investors may catch wind of positive news about the economy and flock to risky assets, only to receive another report minutes later that puts them in a more defensive frame of mind.

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Risk Profiles

Forex traders should also keep in mind that investors have varying risk profiles. While some are prone to take on riskier assets, others may be far more risk averse. There are even market experts who have developed a reputation for being on one end of the spectrum. For example, Nouriel Roubini, an economist who gained fame by predicting the 2008 financial crisis, has received the nickname Dr. Doom for repeatedly making ominous forecasts.3)Retrieved 11 January 2016 http://money.cnn.com/2015/06/01/investing/dr-doom-nouriel-roubini-next-crisis/ Roubini, an economist at New York University, is not alone in being depicted this way. Several professionals have obtained the reputation of being a perma-bear, or someone who is always bearish about either the broader markets, a certain asset class or even an individual stock.

Alternatively, a handful of professionals have been labeled perma-bulls based on the perception that they are always bullish. For example, Abby Joseph Cohen, senior investment strategist for Goldman Sachs, gained fame for successfully forecasting the bull market that stocks enjoyed in the 1990s.4)Retrieved 11 January 2016 http://www.foxbusiness.com/business-leaders/2014/02/05/goldman-cohen-wall-streets-humble-bull/ This steady climb, which some call the greatest bull market in history, saw the Dow Jones Industrial Average surpass 7,000 for the first time ever. While she was able to develop quite the reputation, it was inevitable that some of her predictions would fail to materialise. When the 2008 financial crisis rocked global markets, many analysts, including Cohen, were blamed for not warning everyone about the event’s severity.

Individual Investor Risk Tolerance

Right about now, some may be wondering what to do with all this information. To show how everything fits together, let’s start at the beginning. Before they do anything else, traders can benefit greatly from taking a minute to outline their investment objectives.

Once armed with this basic foundation, they may begin determining their individual risk profile. This entails assessing how much risk they are willing to take on, as well as which individual risks they could face. For example, if a person is planning for retirement in 30 years, he may easily weather short-term declines in asset values and then make up for such losses later on. However, if an investor is looking at a shorter time frame, he may be less willing to incur downside risk.

Some investors start by outlining their risk profile and then use it as a lens with which to interpret any fluctuations in sentiment that take place in the market. For example, if a trader is generally bullish about a certain currency, such as the U.S. dollar, he may be willing to place long bets on it even when the broader market sentiment toward this currency is bearish. In contrast, if a forex trader is bearish about the U.S. dollar, he may be reluctant to make long wagers on this currency even when market participants are generally optimistic about the greenback. Additionally, an investor in this position may be willing to take on bearish bets about the U.S. dollar even when the broader sentiment surrounding this currency is positive.

Summary

Risk-on trading is a technique that can potentially provide investors with great benefit. To maximise their chances of using such approaches carefully, traders may want to familiarise themselves with the different kinds of economic reports that are released and how they affect the markets.

Forex traders may also benefit greatly from being sure they know how particular currencies respond to changes in global risk aversion. For example, many consider the U.S. dollar and the Japanese yen to be safe or “reserve” currencies. In contrast, other currencies, such as the Brazilian real, are considered to be more risky.

As always, risk is inherent to investment, so forex traders should be sure to do their research and/or seek advice from an independent financial advisor before they make any transactions.

Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice. FXCM will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.

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