What is "Risk on" and "Risk off" and how to judge risk sentiment in the current environment?
Updated: Nov 12, 2020
I was prompted to make this article following a Direct Message I received overnight.
The simple take away of what is meant by "Risk On" and "Risk Off" is as follows:
When Risk sentiment is "On" it means market participants are prepared to take riskier bets for a greater return, in essence they are willing to "gamble" (and risk capital) for better odds.
So in a Risk "on" mood, we would look to buy stocks, and sell safe havens, such as precious metals, CHF and JPY.
When Risk sentiment is "Off" it means the market participants are less willing to "gamble" and instead invest in safe havens, that generate low-yielding, yet much safer returns.
So in a Risk "off" mood, we would look to sell stocks, and buy safe havens, such as gold, silver Japanese Yen and Swiss Franc.
Ok, so how do I know if the market sentiment is Risk On or Risk Off?
A very quick and easy way is to examine US Government Treasury Yields.
In this image we see the 3 and 6 month yield is significantly more attractive than the 12 month, 2 Year, 5 Year and 10 Year.
Essentially, it tells us "Risk Off", when the front end of the treasury curve is higher.
After all, if the economic outlook was so good, why would the near-term interest rates be more attractive than the long term? Surely if everything was great, the near-term interest rate would be lower, so people invest in stocks instead and not take refuge in these treasury yields?
A normal and healthy yield curve would be as follows:
And you'll note the current situation is quite the opposite, the yield curve is "inverted", and so this is typically a recession signal.
The parabolic move in Gold recently was largely due to this, (and global macro events of course).
This wraps up a quick article I thought would be useful, especially for trading JPY, CHF and precious metals.