Market sentiment: Risk Appetite and Risk Aversion

In case of the OFS Trading System the emphasis is especially focused on technical analysis, but as soon as you master the basics, one of the first next steps is to gain more in-depth knowledge about the market sentiment as well. The market sentiment concerns the extent of willingness of traders to take risks and concerning this subject we can distinguish between risk appetite and risk aversion.

What does market sentiment mean?

The market sentiment is about the readiness of investors/traders to take risks. In case of forex trading the market sentiment can be very decisive and consequently it could be very important to have a global view of that market sentiment and to what degree it could be affecting certain currencies.

Risk Appetite and Risk Aversion

When we’re talking about the market sentiment in case of forex trading, we’re consequently making a distinction between risk aversion and risk appetite. These terms are related to the state of mind of the investors/traders.

Risk Aversion

Risk aversion has to do with “fear” and global economic uncertainty. When it is a matter of risk aversion, investors/traders will distance themselves from risky investments, such as currencies with a high interest rate, commodities and stocks. They will rather prefer to invest in the so-called safe investments, among such as safe haven currencies (will be explained later on) and bonds.

Risk appetite

Risk appetite is related to “greediness” and a favorable global economy. When it is a matter of risk appetite, investors will consequently prefer to choose the more risky investments like stocks, commodities and currencies with a high interest.

The global economy as an indicator of the market sentiment.

market sentimentWhen the global economy is doing well or it is recovering after a less favourable period, in general there will be a matter of risk appetite. When instead the global economy is doing bad and the prospects are all but favorable or there is a state of agitation, like for instance wars etc., consequently in general there will be a matter of risk aversion.

As an aid to get a proper view of the global economic situation, you should watch the economic data of the US as well as the stock markets on a global level and the prices of commodities. If the American economy is doing well, the global stock markets are flourishing and the prices of commodities are rising, then consequently normally there might be a matter of risk appetite and on the other hand if this isn’t the case, there’s a fair chance that there is a matter of risk aversion. Of course it isn’t always that black and white, but during the past period these were the main indicators. You should however still be aware of the fact that in the future these indicators could well be different.

Which consequences can risk appetite and risk aversion have on the currencies?

The interest rate plays an important role in case of risk appetite and risk aversion. In case of risk aversion the demand for currencies with a low interest rate will be going to rise. In case of risk appetite the demand for currencies with a high interest rate consequently will be going to rise. Apart from this also other factors are playing an important role, like the financial stability of an economy, security and being dependent on a growing global economy.

Safe Haven Currencies

In case of risk aversion you’ll see an increase in the demand for safe haven currencies. These are the currencies which investors regard as a safe investment. During the last period these currencies were especially the US Dollar, the Swiss Franc and the Japanese Yen.

The interest rates of the above mentioned currencies were extremely low. Apart from that many investors consider the US Dollar a safe investment thanks to the long history of financial stability and security. We will not discuss at this moment whether this still is the case caused by the current gigantic public debt, as the vision of the investors on this issue is of overriding importance. It’s true however that the liquidity of the US Dollar, being the reserve currency of the world, is enormous and this provides investors with a lot of confidence.

Also Switzerland is considered to be a safe haven, the main reason for this qualification being the Swiss banks which are well-known for their privacy, stability and protection of the investments. Apart from that Switzerland is also known for its neutrality.

At this moment the Japanese Yen also has the status of a safe haven currency and this is especially being caused by the low interest as well as by the trade surplus.

Though there is a big chance that the US Dollar will remain being a safe haven currency because of its liquidity and the fact that many countries are depending on this currency, there’s always a possibility that sooner or later the safe haven currencies could become the subject of change.

How can you determine the market sentiment and use it in your favor?

Of course you could be able to get a rather explicit view of the market sentiment by way of monitoring everything yourself, but nowadays you can read daily market analysis’s on many websites and read more about the market sentiment on that particular moment. By examining these market analysis’s regularly, you’ll be keeping yourself adequately informed about the current market sentiment as well as about the subjects which could influence this market sentiment.

Conclusion:

To get a nice win ratio with the OFS Trading System, you don’t need to carry out any extensive fundamental analysis’s at all. Though it’s important for you to have a global view of the market sentiment to be able to support your trade setups. With a little bit of extra work you’ll prevent yourself from trading moderate setups which are conflicting with the market sentiment. In addition to that of course there’s also the possibility that you’ll get an additional confirmation as a result of the fact that the market sentiment is fully corresponding with your trade setup.

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