Economics, Risk Management, Risk-On Risk-Off, Technical Analysis, Tips, Trading Education, Trading Tools

Case Study: Feeling Risky? Assessing the Mood of the Market

roro- risk on risk off

Utilizing BT’s “Risk On- Risk Off” (RORO) Analysis Tool

We are in a strangely unique time: a time of uncertainty, fear, and global crisis. COVID-19 has impacted every single one of us in a personal way, and as we all come together by maintaining separation from one another there is a deep loss on all fronts. Not only are we kept distant from those we care for, but most of us are kept from maintaining day-to-day business operations. As a result of individuals needing to quarantine and social distancing guidelines, industries are being greatly affected in different ways. For example, big chain restaurants, such as McDonald’s, which are used to serving millions of customers a day are facing drops in their stocks as a result of only being able to provide takeout. Looking at the bigger picture, as consumer spending decreases, industries are firing their workers which inevitably leads to a reduction of capital into the market. 

This economic “pause” heightens the negative impacts of Coronavirus for everyone – especially day traders, trading in a market that has steered downwards from its long term rise. However, despite an overall downward shift, this uncertainty has also increased the overall volatility of the market – one day market futures rising while the next they might be down. This volatility means that day traders don’t need to push pause while our economic institutions do. They can continue to make purchase and sale decisions at the short-term points which maximize their gains on upswings, even if the market generally trends downward. Although there is no way to know for certain when these swings will occur, by looking at external factors, from general world news to a single chart all compiled in a single “risk-on / risk-off chart”, traders can evaluate the “mood” of the market. 

The Solution 

Risk-on/ Risk-off (RORO) is a tool that measures the sentiments of the entire market. It tracks the cash flow between 5 asset classes—Equities, Bonds, Currencies, Commodities, and Metals—in real-time to give traders a picture of the market’s current risk preference. Traders can use the risk assessment provided by BetterTrader to help determine the optimal time to buy assets, when those assets are most likely to experience increased demand in the near future.

Let’s take a look at an example. Figure 1 demonstrates the market on March 27th, 2020 in the midst of the Coronavirus pandemic. The risk indicator monitor is in the red, meaning that Risk is slightly off. Therefore, traders may choose to not engage in the riskier S&P 500 and rather place his/her money in a different, more secure asset, or alternatively, to short the S&P 500’s weakness. There are a number of features to RORO that allow traders to gauge the magnitude of risks and general trends. Let’s take a look at the different parts of RORO. 

The RORO Real-time Monitor displays either a green or red color, with a value between -100 and 100. The green color represents Risk-on to indicate that the market is generally aggressive and that a trader can engage in higher-risk trades, such as buying oil, S&P 500, or short gold, while the red color represents Risk-Off and urges traders to engage in safer trades, like buying gold or shorting the S&P 500. 

In the Risk Basket feature, each bar represents the magnitude of risk that this instrument contributes to the basket. It shows asset classes and demonstrates if money is being transferred from one asset to another. The tool enables traders to recognize which instruments lead the Risk basket and what lags. A trader will typically choose to buy riskier assets when the basket (in the picture above) is trending on the green area. The figure below demonstrates how the S&P 500 is Risk-Off, while USDJPY is Risk-On. When the basket has a mixed sentiment, as seen above, a trader may be advised to not choose a direction. Instead, a trader may be advised to wait for a confirming mood from RORO before initiating in a directional trade.  

Next, the chart below highlights the various changes of each instrument on a daily basis.

The Risk Basket Over time shows the general trends of the Risk Basket next to the S&P 500 (or to any other instrument in the basket). The yellow line represents the S&P 500, while the other line (Green\Red)) is the risk indicator. We can use the risk basket over time to track the flow of the S&P 500. A trader will choose to buy when the risk is trending upwards. Moreover, a trader may use the chart to determine when to sell when the green has turned a high point and starts trending down. 

Putting all this together, RORO presents a powerful tool for any trader. What may take a trader hours of research and calculations to understand the underlying moods and trends of the market, RORO does in real time. And in these turbulent times, we might just need to stay one step ahead. 

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