In financial markets, there are periods of higher or lower risk tolerance. Various factors can shape risk appetite – macroeconomic, monetary, political, etc. When sentiment is positive, investments are directed towards high-risk assets, leading to their appreciation. In these cases, the market is said to be “risk-on”. When sentiment is negative, investments seek more safety and low-risk instruments rise in value. This is a risk-off market condition.  

For example, government bonds are considered low-risk financial instruments. In financial theory, US government securities are often defined as risk-free because the Federal Reserve is assumed to be unable to go bankrupt. Another asset with a reputation for safety is gold. Among currencies, these are the Swiss franc, the US dollar and the Japanese yen (often referred to as “safe haven” currencies). These will be subject of increased demand in the presence of heightened global uncertainty.

Conversely – when sentiment is positive – the trend will be risk-on and high-risk instruments such as equities will appreciate. In a positive environment, currency pairs such as EUR/CHF and AUD/JPY should increase in value.

How can a trader judge whether the market is risk-on or risk-off?

Risk On/Off is a market condition. The performance of individual asset classes itself speaks for the interests of investors. If today gold and the yen were rising and stocks were falling, we can assume that market participants were pessimistic and looking for more security. For that day, the market was risk-off. It is worth understanding what provoked this behaviour and determining what its potential market impact is. It could be a surprise from a macro indicator, or it could be an event that hides longer-term effects – for example, a change in monetary policy.

The Risk On/Off environment is not a trading signal per se. Most often, it plays the role of a framework within which forex traders take their positions.

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