What is 'Risk-On Risk-Off'

Risk-on risk-off is an investment setting in which price behavior responds to and is driven by changes in investor risk tolerance. Risk-on risk-off refers to changes in investment activity in response to global economic patterns. During periods when risk is perceived as low, risk-on risk-off theory states that investors tend to engage in higher-risk investments; when risk is perceived as high, investors have the tendency to gravitate toward lower-risk investments.

BREAKING DOWN 'Risk-On Risk-Off'

Investors' appetites for risk rise and fall over time. At times, investors are more likely to invest in higher-risk instruments than during other periods, such as during the 2009 recovery. The 2008 financial crisis was considered a risk-off year, when investors attempted to reduce risk by selling existing risky positions and moving money to either cash positions or low/no-risk positions, such as U.S. Treasury bonds.

Not all asset classes carry the same risk. Investors tend to change asset classes depending on the perceived risk in the markets. For instance, stocks are generally seen as riskier assets than bonds. Therefore, during periods of stocks outperforming bonds, this is said to be a risk-on environment. When stocks are selling off and investors run for shelter in bonds or gold, the environment is said to be risk-off.

Earnings, Economic Reports and Central Bank Statements Can Influence Risk Sentiment

While asset prices ultimately detail the risk sentiment of the market, investors can often find signs of changing sentiment through corporate earnings, macroeconomic data, global central bank action and statements, and other factors.

Risk-on environments are often carried by a combination of expanding corporate earnings, optimistic economic outlook, accommodative central bank policies and speculation. As investors feel the market is being supported by strong influential fundamentals, they perceive less risk about the market and its outlook.

Conversely, risk-off environments can be caused by widespread corporate earnings downgrades, contracting or slowing economic data, uncertain central bank policy, a rush to safe investments, and other factors.

Investors Give Up Returns For Safety During Risk-Off and Give Up Safety For Returns During Risk-On

As the perceived risk rises in the markets, investors jump risk assets and pile into high-grade bonds, U.S. Treasury bonds, gold, cash and other safe havens. While returns on these assets are not expected to be excessive, they provide downside protection to portfolios during times of distress.

When risks subside in the market, low-return assets and safe havens are dumped for high-yielding bonds, stocks, commodities and other assets that carry elevated risk. As overall market risks stay low, investors are more willing to take on portfolio risk for the chance of higher returns.

RELATED TERMS
  1. Risk Discount

    A risk discount refers to a situation where an investor is willing ...
  2. Country Risk

    A collection of risks associated with investing in a foreign ...
  3. Operational Risk

    A form of risk that summarizes the risks a company or firm undertakes ...
  4. Professional Risk Manager - PRM ...

    Professional risk manager is a designation awarded to risk managers ...
  5. Risk Management

    Risk management occurs anytime an investor or fund manager analyzes ...
  6. Safe Haven

    A safe haven is an investment that is expected to retain its ...
Related Articles
  1. Investing

    The Risks Associated with Common Investments

    Investing inherently involves some risk. Here are some of the different types of investment risks.
  2. Trading

    Top Strategies Remote Traders Should Follow

    Most traders cannot watch every tick because they have lives away from the markets. These folks can take simple steps to raise the odds in their favor.
  3. Investing

    AT&T Price Target Raised at Jefferies (T)

    AT&T, which has seen its share price rise 12% year to date, still offers some appeal for value seekers even with this outperformance.
  4. Personal Finance

    Risk Management Framework (RMF): An Overview

    A company must identify the type of risks it is taking, as well as measure, report on, and set systems in place to manage and limit, those risks.
  5. Investing

    Key Strategies To Avoid Negative Bond Returns

    It is difficult to make money in bonds in a rising rate environment, but there are ways to avoid losses.
  6. Investing

    Balancing the Different Risks Investors Face

    One of the keys to investing successfully is to balance different types of risk.
  7. Investing

    Determining Risk And The Risk Pyramid

    Many investors do not understand how to determine the risk level their individual portfolios should bear.
  8. Trading

    What Is Your Risk Tolerance?

    Forget the cliches and uncover how much volatility you can really stand.
  9. Personal Finance

    Your Risk Tolerance May Change, So Your Portfolio Should Too

    It is important to rebalance your portfolio when your risk tolerance changes.
  10. Investing

    Low Vs. High-Risk Investments For Beginners

    Understanding risk is key to better investing.
RELATED FAQS
  1. How do I find out my own risk tolerance?

    Learn why risking capital can be risky business, how much risk can you afford and how to determine the right amount of risk ... Read Answer >>
Hot Definitions
  1. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  2. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
  3. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
  4. Cost of Goods Sold - COGS

    Cost of goods sold (COGS) is the direct costs attributable to the production of the goods sold in a company.
  5. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and expenses incurred during a specified period of time, usually ...
  6. Monte Carlo Simulation

    Monte Carlo simulations are used to model the probability of different outcomes in a process that cannot easily be predicted ...
Trading Center