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Forex Risk Aversion

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Old 08-10-2015, 10:27
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Default Forex Risk Aversion

In forex trading, the market tends to be "moody", meaning it follows the moods of it's participants.

These moods come in mainly two flavors, risk taking, and risk aversion.

Risk taking is when investors are not worried about any upcoming issues in the market. They generally feel that there are no surprises coming. Risk aversion is when the future is looking a little murky, or just plain unpredictable.

During the financial crisis of 2008, the forex market overreacted with massive risk aversion. Investors pulled their money out of anything that paid interest and focused on "safe haven" type currencies. This caused a crash on the Australian Dollar and a surge in the US Dollar.

Ironically, the center of the triggers for the financial crisis were based on the United States, but because the US Dollar is viewed as a safe haven during unpredictable times money flowed into it day after day as investors were increasingly unsure of what was to come.

This is true of any time of uncertainty in the markets, even mild uncertainty. Whenever the market terrain is unpredictable, you will see risk aversion. It comes out as the selling of higher yielding assets and moves into lower yielding (safe) assets. Sometimes the moves last for days and sometimes months or years.

Profiting from risk aversion is possible, but ironically risky. To profit from risk aversion, you have to keep an eye on the bigger picture and keep your trading light. In the instance of the 2008 financial crisis, some days had moves up and down of 500 pips. If you traded that looking to make big money with highly leveraged trades, a poor entry could have left you without an account.

The two ways to profit from risk aversion are, stand aside and wait for things to return to normal, or trade small with large targets. It seems like leaving money on the table to trade this way, but the alternative, losing a lot of money on trades, is much worse.

If you plan on using risk aversion to your advantage, just make sure that you have an adequate grip on the reason for the risk aversion.

Failure to know the reason behind the attitude shift in the market could leave you trading the wrong direction after the turn around.



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