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The terms "risk-on" and "risk-off trade" have been more mainstream of late, and Boris Schlossberg defines each one, providing examples of what is in play under each condition.

In the trading and investing world, you’ve probably heard the terms “risk on” and “risk off,” but what does that mean? Our guest today is Boris Schlossberg to talk about that.

Boris, first of all, can you define what “risk on” and “risk off” means?

Generally, in a market, risk appetite or risk assets are ones that are highly correlated with the rise in the equity markets. Basically, the idea is this: When investors feel good about the future, they feel positive about equities, they invest in equities, and equity prices across the world rise.

Also, commodity prices across the world rise, so any asset that’s linked to commodities, to equities, rises with it.

In the currency world, that translates to currencies that have high yield, like the Australian dollar, the euro, the Canadian dollar, relative yield to the rest of safe-haven currencies like the Swiss franc or the Japanese yen, or even the US dollar.

Those currencies seem to perform very much in sync with the rise in risk appetite. When we’re talking about risk on, in effect, we’re talking about those types of currencies that are rising when things are good, and risk off, the dollar, the Swiss franc, the yen, (that are) rising when things are bad.

So when people are willing to take risk, they flood their money outside of the US, outside of the US dollar, outside of those kinds of safe assets?

Yes, and the reason why is because those currencies, of course, produce higher yields. Therefore, they are by definition presumed to be a little bit riskier. It all assumes the idea that further economic growth will produce even higher yields in those currencies, so that’s why you have this self-fulfilling cycle of virtuous rise.

On the other hand, when investors really pull in their horns, that’s exactly the opposite effect and everybody starts to sell those currencies and you have a complete collapse of those values.

Typically gold and some of the metals have been safe-haven investments or a risk-off type of an investment?

Correct, ironically enough, gold has been viewed that way, but if you look at it really over the last several years, it’s also been very highly correlated with risk-on ideas.

Because gold effectively is a commodity, and remember that commodities and equities tend to be running lockstep together. Whenever global appetite is positive, they tend to rise, so gold has actually risen with global appetite, and it has now recently fallen, as we’ve seen, because we’ve had a massive collapse in the equity markets.

That’s had a big negative impact on the Australian dollar, the Canadian dollar, all the risk-on currencies that are commodity linked.

Oil, which has collapsed below $80 per barrel; and gold, of course; and silver, which have had massive declines recently, all because of these types of dynamics.

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