If you have started using TraderUI already then you will have noticed that posts are classified as ‘risk on’, ‘risk off’ or ‘neutral’. Don't be embarrassed if you're not familiar with these terms, I wasn't either when I first started trading. Luckily for me though, an old school bond trader took the time to teach me what these terms meant and why understanding market sentiment is really important.
So to pay the favour forward I’m going to take a few minutes to bring you up to speed with what ‘risk on’ and ‘risk off’ means in terms of market sentiment. If I do a good job then hopefully I’ll have helped you interpret TraderUI’s bespoke models analysis of the posts that land on your dashboard. Oh and if you are already clued up and know all about market sentiment then please feel free to drop a line to support@traderui.com if you fancy writing, or contributing to, a future blog post. We are keen to turn this blog into a community resource.
Technical analysis (TA) is great but we created TraderUI because as a TA trader you can’t just ignore market fundamentals if you want to be successful. Much of this comes via social media based ‘news’ nowadays.
Start with risk management
First, our starting point. Good risk management is essential if you are to become (or already are) a consistently successful trader. Traders need to expose their capital to risk to generate profit and when they are not taking risk they are reducing or eliminating risk to preserve their capital. Keep this in mind as we delve into risk on vs risk off.
What does risk-on mean?
Now let’s tackle risk on first, and in doing so we’ll automatically start to clarify what risk off means too. So, who thinks risk on means take risk/execute the trade? Or maybe you think it means bullish or it’s even a signal to go long. Well it can be all of those things but it’s more specific than that.
Risk on is a label that we relate to riskier markets, assets classes, or individual assets when sentiment towards that market is positive. Risk on means traders are more confident and willing to trade riskier assets because the perceived risk of doing so has been lowered by something. For example, it may be a post from someone influential in that market that has just landed on your TraderUI dashboard. Risk on scenarios tend to prompt long trades on risky assets (your dashboard will often say which ones).
The flip side of risk on moves can be capital flowing away from low risk assets, e.g. Bonds, Gold and certain currencies, sometimes these are referred to as safe havens. This is because traders will move out of those markets to take positions in the riskier markets. In price action terms, risk on sentiment tends to see price increases in risky assets and price decreases in low risk assets. This is exactly the opposite of risk off labels
What does risk-off mean?
You've probably already figured this out now but risk off is when sentiment turns cautious or negative, usually because of a particular development. We’ve seen a lot of this recently with the wars in Ukraine and Iran. Geopolitical unrest is a classic risk off scenario. In risk off conditions the risk associated with risky assets (or sometimes assets specifically connected with the risk in question) is perceived to have risen and consequently the reward of holding a particular asset may now not be enough to justify the risk. This results in selling, and therefore downward price pressure in risky assets. As traders liquidate their long positions in risky assets they will look towards low risk assets for 2 reasons. Firstly, to protect their capital whilst still earning a return. Secondly, from a long trade perspective, to capitalise on price increases in low risk assets that result from buying pressure.
Long and short opportunities
So hopefully that explains risk on and risk off? Don’t forget though that whilst I’ve highlighted long trading opportunities in the explanations above there are also short trading opportunities for each scenario. For example, if a move to risk on causes risky asset prices to increase then there could be a short trade opportunity in low risk assets as prices start to fall because capital is moving out. The same is also true for risk off where there could be opportunities to short risky assets.
How TraderUI uses risk-on and risk-off
Each post in TraderUI is classified by our trained model as risk on, risk off or neutral, and the analysis justifies why. Sometimes posts will have specific impacts on certain assets or asset classes so it’s important to read the analysis you get into your dashboard carefully and not just look at the risk on/risk off icon. Let’s take the Iran war as an example. The war itself and subsequent escalations are all risk off triggers, but underneath this there has been a sustained increase in oil prices because of the supply constraints caused by a war in a major oil producing region and issues with transporting oil through the straight of Hormuz. So, in many of the risk off alerts from posts about the Iran war there have also been significant opportunities to specifically trade oil and natural gas price spikes. These opportunities are brought out in the analysis that lands with the posts.
Why neutral matters
Finally, what about neutral? Our neutral classification is really important as it acts like a filter and stops you getting distracted or wasting time reviewing posts that have no market impact. We all know a certain world leader that routinely posts market moving announcements but also likes to stress how good he is at golf and loves to smear political opponents. Not every post by an influential account is going to be market moving so our neutral classification allows you to ignore these distractions and keep your eye on what's important.
Good luck in the markets!
Damion