Risk on / risk off: How to tell when it makes sense to take risk and when to hold back
In trading, it is often not strategy but timing that makes the difference. And that’s where market sentiment comes into play. What does it mean when you hear the phrase risk off, and why should you care whether the market is currently willing to take on risk or not? In this article, we will break it down.
To risk or not to risk? What risk on and risk off really mean
Every trader faces the same question when entering a position: “Is this a good time to take a risk, or should I wait?”. Whether you’re making decisions based on technical analysis or market news, one thing is clear, understanding the concepts of risk on and risk off can make a huge difference.
These two terms describe market sentiment, or how much risk investors are currently willing to take on. When markets are optimistic and confident, it’s a risk-on environment. When fear or uncertainty sets in, we shift into risk-off mode.
Why should you care about risk on and risk off?
Risk on/risk off is not just textbook jargon. According to research by Chari, Stedman and Lundblad (2024), it is one of the key ways to measure and understand shifts in investor sentiment. And sentiment plays a major role in determining which assets are rising and which are falling.
Risk on: When markets believe in growth
A risk on usually occurs when there is confidence in the economy. Investors are more willing to take risks and allocate money into higher-yielding, higher-risk assets. This often includes:
- Stocks (especially tech and growth sectors)
- Currencies like the Australian dollar (AUD), New Zealand dollar (NZD), or Canadian dollar (CAD)
- Cryptocurrencies
- Commodities like oil or copper
This is a phase with lower volatility, growing markets, and rising trade volumes.
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Risk off: When uncertainty takes over
When negative macroeconomic data, geopolitical tension, or tighter monetary policy hit the headlines, sentiment can shift fast. Investors lose their appetite for risk and move their capital into so-called safe havens. A typical risk-off scenario looks like this:
- The US dollar (USD), Japanese yen (JPY), or Swiss franc (CHF) strengthen
- Gold prices rise
- Stocks, risk currencies, and commodities generally decline
This environment is usually marked by higher volatility and a more cautious approach across all markets.
How to tell if the market is in risk-on or risk-off mode
If you want to understand what is really happening on the markets, there are a few key indicators that can help you read the current sentiment:
VIX – the volatility index
Often called the “fear index”. When VIX rises, it signals that markets are nervous and we’re entering a risk off phase. When it stays low, it usually means calm conditions and a risk on mood.
US Dollar Index (DXY)
A strong dollar typically signals a move away from risk, that is, a risk off environment. When the dollar weakens, it suggests that investors are seeking yield and are more open to risk.
Economic reports and geopolitical context
Central bank meetings, inflation data, job market reports, or geopolitical events all play a major role. Sometimes a single unexpected comment from the Fed or surprising data from China can trigger a major shift in sentiment.
Why risk on/risk off is hard to grasp for beginners
If you’re just starting out with trading, you’ve probably heard that it’s smart to follow the “market mood”. But the reality is, sentiment isn’t always that clear-cut. Risk on/risk off regimes can change quickly, and they’re not always easy to interpret.
The big problem? Beginners often focus on just one instrument, like EUR/USD or gold, without understanding the broader market context. And that context usually tells you whether taking a risk even makes sense in the current situation.
Mistake #1: Trading without checking the market mood
Opening a trade just because “there’s a signal” can backfire, especially if the market has already shifted from risk on to risk off. For example: a strong breakout on a stock or crypto asset might not mean much if the broader market is dealing with a banking crisis or looming recession.
According to Lee (2012), these rapid shifts in sentiment have a major impact on capital flows – from stocks and currencies to commodities. And beginners often don’t have enough awareness to spot these changes in time.
Mistake #2: Ignoring safe haven assets
In a risk-off environment, the assets that “work” often change completely. While most retail traders wait for crypto or stocks to bounce, large players are already buying USD, yen, or gold. If you’re avoiding these assets, you’re missing potential opportunities.
How to learn to read market sentiment
The easiest way to start? Follow the flow of money. The switch between risk on and risk off is always reflected in how capital moves. According to Chari et al. (2020), these capital flows shape the relationship between emerging markets and major economies.
Here’s a simple plan to follow:
Watch how currencies and indexes move
- If stock indexes are going up and the USD is weakening → risk on
- If stock markets are dropping and the dollar, gold, or JPY are rising → risk off
Check VIX and DXY once a day
No need for fancy tools. Just open the VIX chart and check if it’s rising. If it is, chances are we’re heading into a risk-off environment. And in that kind of market, it pays to be more cautious.
Don’t trade in isolation
Always ask yourself: “Does this trade make sense in the context of the overall market?” If we’re clearly in risk-off mode, there’s no point in going long on a growth stock just because your strategy shows a signal. The market can steamroll you.
What does a trading strategy that respects risk on/risk off look like
Your trading approach should adjust to market sentiment. Here’s what that looks like in practice:
In a RISK ON environment:
- Go long on stocks, indexes, and crypto
- Use breakout or momentum strategies
- Focus on currencies like AUD, NZD, CAD
In a RISK OFF environment:
- Focus on USD, CHF, and JPY
- Consider defensive setups or avoid trading entirely
- Always have an exit plan ready
Interesting fact: a study by Halko & Kaustia (2015) showed that even something as simple as background music can affect your willingness to take risk. That’s why it’s crucial to stick to a trading plan that brings you back to logic, not emotion.
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Why you should really care about risk off
If you learn how to read market sentiment, you’ll gain one of the biggest trading advantages: you won’t be trading blind. In practice, that means:
- You’ll avoid unnecessary risk during volatile periods
- You’ll know when to be active and when to sit tight
- You’ll understand why some trades failed, even if the setup looked perfect
Risk off isn’t just a theoretical concept; it’s the market’s way of warning you that this might not be the best time to take chances.
How to start working with the risk on/risk off regime
You don’t need to control the entire market. Just follow a few basic steps:
- Check VIX and DXY daily
- Watch what USD, JPY, and gold are doing
- Ask yourself: “Is the market in the mood to take risks?”
If you’re not sure, don’t jump into live trades. Use a demo trading account to test different scenarios without the pressure of real losses.
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Resources
Chari, A., Stedman, K., & Lundblad, C., 2024. Risk-on/Risk-off: Measuring Shifts in Investor Sentiment. The Federal Reserve Bank of Kansas City Research Working Papers. https://doi.org/10.18651/rwp2024-12.
Lee, W., 2012. Risk On/Risk Off. The Journal of Portfolio Management, 38, pp. 28 – 39. https://doi.org/10.3905/jpm.2012.38.3.028.
Chari, A., Stedman, K., & Lundblad, C., 2020. Capital Flows in Risky Times: Risk-On/Risk-Off and Emerging Market Tail Risk. NBER Working Paper Series. https://doi.org/10.2139/ssrn.3676620.
Halko, M., & Kaustia, M., 2015. Risk ON / Risk OFF: Risk-Taking Varies with Subjectively Preferred and Disliked Music. PLoS ONE, 10. https://doi.org/10.1371/journal.pone.0135436.
