Chris Pulver is a full-time trader and Senior Currency Strategist at Market Traders Institute. To know more about the systems, tricks, and strategies that Chris uses to target profitable trades, you can sign up for his free weekly newsletter here.
The market moves in cycles – there’s boom, consolidation, and bust. And knowing how to trade these cycles can make a huge difference in your trading success.
So, let’s talk about how you can define these market sentiments and the tools that could help you trade them for potential profits.
Risk-On and Risk-Off Trading
Risk-On Trading, also known as Risk Appetite, refers to when the market sentiments are bullish. It’s where the market participants have a high-risk appetite and bid up the prices of assets on the back of positive sentiments.
So, typically, a risk-on environment is when…
- Sentiment is Bullish
- Stocks and Stock Indices are Bullish and Gaining
- There’s Trader and Investor Optimism
The saying goes, and rightly so, as – Bullish markets are built on hope.
On the other hand, Risk-Off Trading or Risk Aversion happen when the market sentiments are bearish. In this situation, investors become more risk averse and sell assets, thereby sending their prices lower.
A risk-off environment is when…
- Sentiment is Bearish
- Stocks and Stock Indices are Bearish and Falling
- There’s Trader and Investor Fear
The saying here goes as – Bearish markets are built on fear.
Let’s now have a look at how you can use these readings to trade the Forex market.
Forex Pairs for Risk-On and Risk-Off Trading
As we discussed, a risk-on environment is when we will see bullish trades.
The currencies that get bullish during this time are called Risk-On Currency Pairs. They are…AUD/CAD/NZD/GBP.
Each of these currencies is closely tied to a commodity. The CAD and GBP are tied closely to oil, the AUD is tied to gold, and the NZD to food prices and imports-exports. So, when we see risk-on trading, we tend to see these currencies feed and fuel the growth. And so, they are more likely to get stronger and perform better in a risk-on environment than the other safe haven currencies.
On the other hand, the currencies that get bullish during a risk-off environment are called Risk-Off Currency Pairs. These are…USD/JPY/CHF.
They are considered as safe-haven currencies and tend to fund the world’s growth. And these currencies commonly become much stronger during times of concern and fear (risk-off environment) as safer bets.
Let’s look at an example to understand how these forces all work together.
2020 was a poster child for the risk-on and risk-off trading environment.
Have a look at the SPY, an index which tracks the S&P 500, during the years 2019 and 2020:
We saw a risk-on rally from August 2019 till early 2020. And that was the time when we saw the AUD, CAD, GBP, and NZD getting stronger.
The markets then took a U-turn in February 2020 and started plunging on the back of uncertainties of Covid. This led to a dramatic risk-off environment and we saw the USD, JPY, CHF trading stronger during this time. (On the other hand, the risk-on currencies were trading on a weaker note.)
That means the risk-on and risk-off currency pairs are also correlated to the movements and sentiments in the stock market.
When the stock markets are bullish, you can expect the AUD, CAD, GBP, and NZD to trade on a positive note. And when the markets are bearish – you should expect the USD, JPY, and CHF to trade on a positive note.
Here’s an example:
The AUD/USD has performed well when the stock markets were in a risk-on environment and it has fallen when the markets entered a risk-off environment. This performance is quite similar to how the SPY or the stock market was moving!
So, to quickly wrap it up…
It is easier to be a buyer – and a consistent buyer – in a risk-on environment and be a seller – and a consistent seller – in a risk-off environment. And while doing so, understand which currency pairs perform well in each of those time-frames to corner some potentially profitable trades.
You can check the various currency pairs and how they’ve performed in different conditions to get a better sense of their interaction.
Chris Pulver, Senior Currency Strategist at Market Traders Institute, has also recorded a short video on this concept a while back, which you can Watch Here.
To know more about such potentially profitable trading strategies and tools, you can sign up for Chris’ free weekly newsletter.
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