RISK off is an old concept, but it has recently started to re-emerge on the back of stock markets declining slightly more than people had been expecting. It’s a term used when people opt for safety over potential returns. As an example, the FTSE 100 is down 7.8 per cent since August, which far exceeds the average dividend yield. In the FX world, traders look for the carry trade, which means that you borrow a sum of money in a country with low interest rates and deposit the proceedings in a country which offers higher interest rates. You then get to keep the difference.
The key characteristics of a risk off market are that stock markets are in a downtrend and the Japanese yen and US dollar are strengthening. At the same time, people will withdraw support from high-yielding currencies, like the New Zealand dollar, or from currencies with a risk premium, like the euro.
The fact that the yen and stock markets are correlated is a great advantage, as we can choose which markets to use if we want to trade in the case of a risk off situation. Ask anyone that has been short the FTSE 100 how nerve-racking it can be. You can be up on a great deal one day only to give back up to 80 per cent of your gains 24-48 hours later. The fact that the ups and downs are not smooth makes it easy to get in trouble. However, trading the same idea, via a currency pair like euro-yen, is usually less abrupt. You also tend to experience fewer gaps, as the volume is better in forex trading. Keep this in mind next time you trade.
Alejandro Zambrano is a currency strategy analyst at DailyFX.com. He leads a monthly educational seminar for FXCM live clients at http://bit.ly/PremiumEDU
You can follow him on Twitter @AlexFX00