Risk Aversion

The term "Risk Aversion" is used to describe the risk sentiment of traders and investors in financial markets to reduce risk exposure and focus on protecting capital.

In a "risk-off" environment, you'll notice rising prices for safe-haven assets (such as the yen and gold), and riskier assets (such as stocks and gold) Commodities fell.

The opposite of “risk aversion” is “risk on”.

You will often hear markets described as "risk on" or "risk off".

They are all shorthand for global market sentiment.

"Risk On, RiskClose" is also known as "RORO".

What is “risk aversion”?

When market participants feel pessimistic about the economic outlook, or when unexpected super negative news or increased uncertainty about the future, market participants will want to sell risky assets and buy safe-haven assets instead.

That’s “Risk Aversion”.

When you hear traders are in “risk-off” mode, it usually means they are reducing leverage, selling risky assets, buying “safer” assets, or even cashing out.

What is a typical “safe haven” asset?

You should expect a general decline in the stock market.

A good indicator is to look at U.S. stock indexes like the S&P 500 and the Dow Jones and see if they are both moving lower to confirm how strong the "risk-off" sentiment is.

“Safe-haven” assets would include U.S. Treasuries and German Bunds, as both are considered (almost) risk-free.

Among currencies, USD, , JPY, and CHF tend to rise as traders unwind carry trades.

An arbitrage trade is a transaction in which Japanese yen is borrowed at a low interest rate and then used to purchase higher-yielding (riskier) assets in other markets.

Gold prices typically rise while government bond yields fall.

What is “risk”?

When market participants feel optimistic about the economic outlook. They will drive up the prices of risky assets.

That’s “Risk.

When you hear that traders are in "risk-on" mode, it usually means that they are buying risky assets, often using leverage.

What is a typical “risky” asset?

For stock traders, stocks in industries that are more dependent on economic growth.

For bond traders, lower-rated but higher-yielding corporate and sovereign bonds are considered “risky” assets.

For Currency Traders:

  • Commodity currencies such as the Australian dollar, New Zealand dollar, Canadian dollar and Norwegian krone.
  • Emerging market (EM) currencies , such as MXN, ZAR, TRY, and BRL.

For commodity traders, industrial metals like copper and energy products like oil.

How do you know when the market is in a "risky state"?

You can use our real-time risk on/risk off meter.

If you want to learn more foreign exchange trading knowledge, please click: Trading Education.

Related Posts