If you have spent any time involved in financial spread betting over the past year or so you will have invariably come across the terms “Risk-on and Risk-off”. We mention these terms often in our LS Trader updates.
Why have these terms become so popular lately, what do they mean and how can you use this information to improve your spread betting? Since 2007 the global economy has been mostly in meltdown following the credit crisis and the stock market crash in 2008. This was a time of risk-off. In March 2009 the markets bottomed due to government stimulus and we saw a return of risk-on.
Since then the markets have switched between periods of risk-on and risk-off and this has a major impact on the global markets, including stocks, commodities, currencies and bonds, all market sectors that we trade at LS Trader.
When to go long
During risk-on periods, investors and traders are confident in the markets and are piling into markets that they think will help them generate high returns. These trades are generally considered more risky than other more conservative trades.
When the market participants go to risk on, the following markets all tend to rally at the same time:
- Stock indices, such as the S&P 500 and Nasdaq 100
- Commodities, such as metals and energies
- High yielding or commodity based currencies, such as the Australian, Canadian and New Zealand dollars
- Safer currencies such as the U.S. dollar tend to decline
When to go short
During risk-off periods, the above list can be turned on its head and all the above markets tend to sell-off, leading traders to buy into:
- The U.S. dollar and to a lesser extent, the Swiss Franc and Japanese Yen
- Government bonds such as 30 year U.S Treasury Bonds and T-Notes.
These two scenarios of risk-on and risk-off are also effectively linked to inflation and deflation expectations. The top list is generally indicative of inflation and the bottom list is generally indicative of deflation.
Because of the risk-on versus risk-off scenarios, most markets are all moving as one, so during risk-on, all the markets in the top list go up while all the markets in the bottom list decline, and during risk-off the opposite happens. This is easily evidenced by the prevailing market trends.
Using this information, spread bettors have a road map as to where the markets will likely be heading in the near term. The problem with this is that of late the markets have been switching frequently back and forth between the two scenarios.
This is why the trusted rules of trend following, trading with the long term trend, riding winners and cutting losses works, as by trading with the long term trend you are likely going to be on the right side of the risk-on – risk-off trade and overall market moves. You will also be in a position to run up big profits if the markets go on to develop an extended trend, and also cut losses quickly should the scenario change, leaving the bulk of your spread betting capital intact for when the market direction becomes clearer.
The LS Trader System
At LS Trader, our spread betting system automatically includes systematic rules to incorporate the above. If you are interested in finding out more about our proprietary spread betting system, the LS Trader system, please click here for a 30 day trial.