Playing the “risk on / risk off” trade

September 20, 20123 Comments

Without a doubt, the pattern for stock markets has, over the past 2 years, turned to a “risk on, risk off” rotation. Market events and political announcements provoke traders to rotate in and out of higher or lower beta/risk securities. Readers of this blog need not be convinced that we are no longer in a “buy and hold” environment. We haven’t been in that type of investment climate for about 10 years, but it’s really been the past 5 years or so that the buy/hold investors have been clobbered. As traders, we want to take advantage of this risk on/ risk off rotation. Let’s take a look at a few sectors to consider when trading either side.

Risk-on

The first and most simple choice when looking at a risk-on rally is to play the broad indices. North American index ETF’s worth considering are those representing the S&P500, The DJIA, NASDAQ and TSX60. From there, higher beta sectors such as energy, metals, gold, US banks and materials can add more upside than the broad indices. Note the massive breakouts for these sectors during the pre-QE3 and post-QE3 risk-on rally. I’ve posted the gold and US bank charts to illustrate two of these breakouts.

Risk-off

When traders flee to safety, one of the first destinations is the U.S. dollar. Say what you will about the US debt problems and economy- it remains the worlds reserve currency. Note on the chart the rotation out of the USD began as the risk-on stock market rally gathered steam. It’s a little oversold now as noted by the momentum indicators on the chart above, but the trend is currently bearish for the USD. Moving with the dollar is the US long bond. Equities obviously see the downside of a risk-off atmosphere, but some Canadian sectors that have been benefitting from the risk-off trade include telecom, utilities, and infrastructure. Bellwether telecom BCE, for example, rose during the bearish months leading up to the recent QE3 rally, then sold off as traders took profits from this safe-haven stock to move into the risk-on sectors mentioned above.

Aggressive or sophisticated traders can also consider VIX, Inverse, bearish option strategies and shorting to play the risk-off trade.

 

3 Comments

  • Hi Keith,

    I was taking a look at the heavy volume on both BCE and RCI on Friday. What do you think this implies. I was looking at past volume spikes for BCE and I noticed this usually happens before a nice intermediate rally.

    Regards,

    Jordan

    Reply
    • Often a spike in volume can imply a pending change in trend. Given the potential for an overbought correction right now, these stocks (being “risk-off” stocks) might rally. We shall see.

      Reply

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