Why Learn About Risk-Off Trading?
Some investors harness risk-off trading in an effort to meet their investment objectives. This particular strategy hinges on the broader sentiment of the global asset markets, with the belief that the rising or falling confidence of investors can motivate them to favour one asset class over another. By learning about risk-off trading, investors can obtain one more tool for use in their arsenal.
News And Sentiment
Forex traders may benefit from knowing that the sentiment of the broader investment markets can be affected by the release of news. If investors receive news that makes them less confident in business conditions, for example economic reports that fall short of expectations, they will likely opt to purchase less-risky assets.
While these assets may offer greater safety of principal, this perk may come at the expense of lower potential returns. In forex trading, analysts typically categorise certain currencies, for example the U.S. dollar and Japanese yen, as being safe.
Alternatively, other currencies, for example those used by the governments of emerging-market nations, are often portrayed as being less safe by analysts. These currencies, for example the South African rand and the Chinese yuan, may carry greater risk, but they may also offer higher potential returns.
When investors receive news that makes them more confident about business conditions, they may flock to riskier assets, more specifically riskier currencies for those involved in forex trading. This is referred to as risk-on trading.
Duration Of Trends
While it may be easy for forex traders to spot the sentiment that coincides with risk-off trading, it may be far more difficult for them to predict how long this kind of mindset will last. For example, investors may receive a report indicating that China's economy grew slower than expected during the last quarter, an event which could make them nervous and increase their likelihood of buying risk-off assets. However, they may receive a handful of strong reports within the hour, making them more optimistic and therefore shifting their preference back toward riskier assets.
Alternatively, investors may trade assets in a nation that experiences a prolonged period of economic malaise, for example the decade of lackluster business conditions Japan experienced during the 1990s.
Individual forex traders may benefit from familiarising themselves with risk profiles before making any particular transactions. While some investors are very tolerant of risk, others are far more conservative.
To determine their risk profile, traders should consider how much risk they are willing to incur and which risks in particular they will likely face. Before they even look at this, they should know their investment objectives. Some investors may be interested in preserving capital, while others may want to accumulate wealth over a long period.
Outlining these goals can be very helpful to determining one's risk profile. If a person is saving for retirement 30 years from now, he may be very willing to incur substantial risk. However, if someone is mainly looking at preserving their capital, he may be far less interested in taking on risk.
Once investors have determined their risk profile, they can use it as a lens with which to view broader shifts in market sentiment. For example, a trader with a more conservative risk profile may stick to less-risky investment strategies even when markets become more optimistic. Should the sentiment of the market become more pessimistic, the investor might become even more conservative.
A trader who is generally bullish about the Japanese yen may be more likely to take long positions on this currency than other investors. He may also be willing to stick with such strategies even when others are fleeing the currency.
By learning the basics of risk-off trading, including the economic news that generally triggers this activity and how different currencies will likely react to this trading, investors can potentially derive substantial benefit.
They should also bear in mind that risk is inherent to investment. Forex traders should be sure to do their homework and/or seek advice from an independent financial advisor before they make any transactions. Losses can exceed deposited funds.
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.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…