When trading in the forex market, understanding investor sentiment is essential for making informed decisions. Two key concepts every trader should know are
"Risk-On" and
"Risk-Off". These terms describe investors' attitudes towards risk and directly influence currency performance.
What Do Risk-On and Risk-Off Mean?
Risk-On indicates a market phase where investors are optimistic, willing to take on greater risks, and invest in more volatile and profitable assets. Conversely,
Risk-Off represents a period of risk aversion, during which investors prefer safe and stable assets to protect their capital.
Practical Examples of Risk-On and Risk-Off
During the 2008 global financial crisis or the COVID-19 pandemic in 2020, markets rapidly shifted towards a Risk-Off sentiment. In these situations, currencies tied to emerging economies or heavily dependent on commodities (such as AUD, NZD, or CAD) experienced significant depreciation. In contrast, safe-haven currencies like USD, JPY, and CHF saw substantial appreciation.
Risk-On vs Risk-Off Currencies: What Are They?
Risk-On Currencies
- Australian Dollar (AUD): closely correlated with commodity prices such as iron, coal, and gold.
- Canadian Dollar (CAD): primarily influenced by oil prices.
- New Zealand Dollar (NZD): tied to agricultural exports (dairy, meat).
- Emerging Market Currencies (BRL, ZAR): offer high yields but with greater volatility.
Risk-Off Currencies
- US Dollar (USD): the quintessential safe-haven currency due to its role as a global reserve.
- Japanese Yen (JPY): favored during periods of uncertainty thanks to low interest rates and trade surplus.
- Swiss Franc (CHF): appreciated for Switzerland's political and economic stability.
- Euro (EUR): occasionally considered a haven during European regional crises.
What Influences Risk-On/Risk-Off Sentiment?
Several factors can determine whether the market is in a Risk-On or Risk-Off phase:
Global Economic Data
Macroeconomic data such as GDP, inflation (CPI), unemployment, and labor reports (e.g., Non-Farm Payrolls in the US) significantly influence sentiment. Positive data encourages a Risk-On attitude, while negative data pushes towards Risk-Off.
Geopolitical Events
Geopolitical tensions, trade wars, or military conflicts generate uncertainty in financial markets. For example, the Russian invasion of Ukraine in 2022 triggered a flight to safe-haven currencies like CHF and JPY.
Central Bank Policies
Interest rate decisions by major central banks directly impact sentiment. Restrictive monetary policies (rate hikes) tend to favor safe-haven currencies like USD; expansionary policies (quantitative easing) stimulate a more risk-friendly climate.
The Impact of Commodities on Forex Sentiment
Commodity prices play a crucial role in determining sentiment:
Oil and the Canadian Dollar (CAD)
Canada is one of the world's leading oil exporters. When crude prices rise, the CAD tends to appreciate. For instance, during the post-pandemic recovery in 2021, the increase in oil prices significantly strengthened the Canadian dollar.
Gold and the Australian Dollar (AUD)
Australia is among the world's largest gold producers. An increase in global gold demand can support the AUD even in periods of risk aversion. During the COVID-19 pandemic in 2020, the surge in gold prices helped limit AUD losses despite the general Risk-Off climate.
How to Trade with Risk-On/Risk-Off Sentiment?
Although there is no single strategy based solely on risk-on/risk-off sentiment, understanding this concept allows traders to better anticipate currency movements:
- Constantly monitor global economic news: use up-to-date economic calendars to anticipate changes in sentiment.
- Exploit correlations with commodities: for example, go long on CAD when oil prices are expected to rise or on AUD when gold is growing.
- Diversify positions: combine risk-on currency pairs with risk-off pairs to balance the portfolio during uncertain market phases.
Correctly interpreting the risk-on/risk-off dynamic can represent a significant competitive advantage over traders who rely solely on technical analysis. Integrating this fundamental analysis into one's strategy allows for capturing broader opportunities and better managing the risks associated with forex trading.
