Risk On

The phrase “risk on” describes a market sentiment where traders and investors are willing to take on risk in the financial markets. In a “risk on” scenario, you will observe an increase in the prices of high-risk assets like stocks and commodities, while safe-haven assets such as the Japanese yen and gold tend to decline.

The counterpart to “risk on” is “risk off.” Markets are frequently characterized as either “risk on” or “risk off,” serving as shorthand for the prevailing global market sentiment. The concept of “Risk On, Risk Off” is also referred to as “RORO.”

What does “risk on” mean? When market participants are optimistic about the economic outlook, they tend to drive up the prices of riskier assets. This is what is meant by “risk on.” When you hear that traders are in “risk on” mode, it typically indicates that they are purchasing risky assets, often using leverage.

What about “risk off”? When market participants are pessimistic about the economic outlook, or when negative news arises that heightens uncertainty, they will seek to sell risky assets and instead invest in safe-haven assets. This is referred to as “risk off.” When traders are in “risk off” mode, it generally means they are reducing leverage, divesting from risky assets, and opting for “safer” assets or even cash.

What are common “risk on” assets? For stock traders, these include stocks from sectors that are more reliant on economic growth. For bond traders, lower-rated but higher-yielding corporate and sovereign bonds are viewed as “risk on” assets. For currency traders, commodity currencies like AUD, NZD, CAD, and NOK, as well as emerging market (EM) currencies such as MXN, ZAR, TRY, and BRL, are considered “risk on.” For commodity traders, industrial metals like copper and energy products such as oil are typical “risk on” assets.

What are typical “risk off” assets? In a “risk off” environment, you can expect stocks to decline across the board. A reliable indicator is to monitor U.S. stock indices like the S&P 500 and DJIA; if they are all trading lower, it confirms the strength of the “risk off” sentiment. “Risk off” assets include U.S. Treasuries and German bunds, both regarded as (almost) risk-free. Among currencies, the Japanese yen and the Swiss franc often appreciate as traders unwind carry trades. Carry trades involve borrowing Japanese yen at a low-interest rate to invest in higher-yielding (riskier) assets in other markets. Additionally, gold prices typically rise, and government bond yields decrease during “risk off” periods.