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Risk ON/OFF analysis in markets




One of the relatively hidden concepts in the retail industry of trading is a risk on/off analysis. Or the term i often use "risk profile analysis".

In professional circles of investing and even mainstream media, the risk on/off approach gets plenty of highlights, but in retail circles, it is a nearly taboo subject. You have more chances of rando-picking next 10X ticker than finding someone in retail who understands the subject.


Many traders who trade SPY and large caps never bother looking into risk on/off or what in particular drives equity markets on a daily basis. This is why so much attention is spent on pivots, levels, and trying to guess what SPY might or might not do, but very few bother studying the underlaying mechanics of what drives the prices of equities. It is very helpful to have a background of the move explained, even if it's only in hindsight.


All asset classes are linked to each other more or less, and relationships (and competition) is what drives the price moves on each asset class.


This article intends to highlight some of those relationships and what traders or any market participants should be looking for to project moves in markets better.

I believe that partially why this analysis gets a lack of interest, is because many traders are young and it is not within the interest of people to study "boring" markets such as bonds or gold and the impact they might have on equity markets. Additionally, it isn't the easiest concept to grasp especially when one is younger due to certain "world mechanics" that are part of the risk on/off approach. By "world mechanics" I mean there is a lot that goes into it because those are big asset classes each with a lot of their unique action and functionality.

However luckily, there is a way to condense explanations down to the point where it can be quicker to apply in my view, hence the outline here.

One of key benefits of using and doing risk profile analysis is to not overstay the cycles. To not get bagged. To abandom the ship when the tide is turning clearly. Or at least, to reduce this as much as possible, because we are all still human and flop every now and then.


What does risk-on, or risk-off means in simple terms?




Think about it in terms of flight to safety or move into risk.


For example, when things are good in the economy, people are seeking risk and higher returns. They put their capital into places that are riskier and can yield good rewards. Anything worthy of great reward typically will involve a good amount of risk.


When things in the economy get worse (recessions) people become risk-defensive. They might pull money from risky projects and park it in their bank accounts until the situation improves.


It is the same way money flows in markets and how institutions think on a daily basis. The only difference between you as a consumer and an institutional investor is that a typical consumer makes risk on/off moves only once or a few times a year. Meanwhile, institutional investors do those re-positionings constantly on a daily or weekly basis. Which explains constant push-pull dynamics in markets. Big money is not static. And those that are eventually get flushed out in major cycle changes.


Risk ON: The market seeks riskier assets that have higher % return potentials. Typically within equity space or emerging market currencies or other exotic instruments (small-caps).


Risk OFF: The market seeks safer assets that have low % return potentials but at least do not have significant risk behind them. Because if the situation "out there" is problematic, one isn't looking for returns, but just to keep what they have.


Or to use another analogy from poker which many might be closer to:

Risk ON is when you are participating (not folding) and adding bets because your cards are good and opponents are judged to be either a match or weaker.

Risk OFF is when one folds because the cards are not optimal and it is likely opponents holds a better hand. When you fold, you go back to the cash position sort of speak.



Typical asset responses

Let us briefly cover key relationship dynamics. Those are typical reactions of each asset class depending if risk ON or risk OFF is in play. We start with these basics and then build on top with bias.


Risk ON:

-SPY and equities higher

-bonds (TLTs) higher

-dollar lower

-bond yields lower



Risk OFF:

-SPY and equities lower

-bonds (TLTs) lower

-dollar higher

-bond yields higher



Gold and crude oil are not included in the above analysis, because their reactions to risk on/off are much less stable, they have more variations. It requires more in-depth explanation to get this point across so let's leave them out for now.

For example, sometimes when risk-on ignites gold will perform well, because of how strongly the dollar has droped (which we can see in November). But sometimes risk-on is present while the dollar is flat or somewhat strong which can make gold struggle (stay inside of range).

This can create more confusing input into the analysis and requires more experience on the macro side to interpret the input. The same goes for crude oil.



Economy, news and risk ON/OFF correlation




From economic-functionality perspective:


RISK OFF:


When things worsen in the economy (per news and data releases), the fund managers might be more eager to sell the equities. So they start to liquidate SPY or other large-cap positions. Leading to the decline of that asset class.


At the same time due to worsening (catalyst) present in the economy, they might also sell some bonds, which leads to bond yields going higher (yield is seeking bidders at higher prices).


At the same time, some of those participants might move their liquidated cash position into an actual cash position by converting or buying the USD. This leads to USD strengthening in such situations of worsening economic performance and therefore a risk-off reaction. When asset managers and market participants become defensive due to worsening conditions, they might move some portion of portfolio into cash and create bid on USD. Altough the bid on currency comes from multiple other sources at same time, for sake of simplicity lets keep it with only explanation above.


RISK ON:


When things improve in the economy (per news and data releases), As new positive catalysts that shows economic improvement hits the market, the market might be more eager to bid on SPY and equities in general. When things are going well many market participants start to seek risk and higher returns (because overall risk has decreased due to improving conditions). This leads to SPY moving higher often in such cases.


At the same time, bonds might also get bought from institutional investors which pushes yields on bonds lower. Improving economic conditions means that countries can borrow money at cheaper rates, leading to yields declining.


At the same time dollar might get sold off, because people and money managers are less interested in holding cash positions (being defensive) and instead go into offensive mode seeking risk. Seeking risk means exiting a cash position, and putting cash inside a risk pool (buying equities, crypto, real estate, and what not).


This is very roughly the basics of the relationship between those assets.


Multi time frame analysis



 One should always use two-time frames to do the risk on/off analysis. Using just a single time frame can quickly remove the context, especially on more quiet and neutral days. It can also create too much whip-saw bias shifting if one is only looking at the broad market flows from a single time frame. It's always much more stabilizing to have two different time scales in mind, to see how lower time frames should match the higher time frame. 


 Personally, I use 1-minute charts combined with 15-minute charts to do a split analysis on each and to see how 1 minute fits into the bigger picture of a 15-minute analysis. The idea is to establish two trend dynamics:


-bigger picture money flows currently present (15 minutes)


-smaller short-term picture money flows currently present (1 minute)


And then combining both, especially on neutral days. What is meant by that, is that when on a short time frame there is strong ignition either on the positive or negative side, multiple time frame analysis is not as important. Because catalyst ignitions (which usually cause that) can actually change big-picture money flows from a short-term perspective. What is meant by that for conceptual example: -15 minute trend is in risk-on for past 10 days

-1 minute changes trend direction quickly and sharply on news catalyst into risk-off

-this then leads to trend change that lasts for 5 days (changes higher time frame). It started on short time frame ignition/reversal. This is why tracking short time frame changes matters every now and then.


To put above conceptual example into practical example we can use November 1st risk-ON ignition. We had for 3 weeks of October semi risk-off environment (Mid-East conflict as main cause of that), which then was reversed intraday on November 1st. And that trend reversal lasted for nearly the entire month of November. The point is, if one is only tracking higher time frames, you would not recognize that change until all the way into the middle of the month of November. You would have missed almost 10 days of hot action because of not implementing both time frames at once.




The conclusion is, that low time frames bend to high time frames if we have more neutral-ish days intraday (on low TFs). Higher time frame flows will generally "scoop up" the smaller time frame deviations and turn them towards the flows of high time frames.

However: When low time frames have strong surprise catalyst that can cause flows to not shift just a little bit but instead significantly, as we have seen above on November 1st. Significant tilt on short time frames can then start to chip away at high time frame flows and turn those flows completely. This is why both time frames need to be used.


Double TF use counts the most on neutral days instead. For example, when 1 minute is relatively flat and no asset prices are moving anywhere much (gold flat, equities flat, dollar flat), on a day like that, it is very helpful to have in mind big picture context (15-minute time frame) to see what is to expect from the day like that. And which direction one should stay with. For example, if 15 minutes suggests that the market has been in risk-ON mode for the last 2 weeks, and the current 1-minute short-term TF is flat, this should give is slightly more bias towards further bullish expectations. 


To put some combinations forward (roughly speaking): -15 min TF risk-ON + 1 min TF risk-ON = risk-ON with high score. -15 min TF risk-ON + 1 min TF neutral (flat) = risk-ON with lower score

-15 min TF risk-ON + 1 min TF risk-OFF ignition = neutral or risk-OFF (if flows kick in hard)


Those scoring variations allow us to structure better plan each day and what to expect out of tickers, rather than forcing same expectations every day, its better to follow institutional money flows and adjust based on how risk proned "the money" is at that moment. No matter what ticker you trade, it will be impacted by risk on/off profile of broad markets. No asset is excluded. Including the anarcho-capital exotic island of crypto markets. In fact crypto even more, because Bitcoin has very high sensitivity to global liquidity, more than many other asset clases.



Tradingview chart setup


For anyone interested in using a similar visual setup to the one shown in the image examples here, feel free to use Tradingview and overlay all the assets in a single chart window.

It is more practical than having 5 separate chart windows open to see all the assets as relationships and divergences are not as clear to see that way. There are perhaps other charting platforms and you can replicate the setup similarly. There is no promotional aspect for Tradingview whatsoever, it is just that they offer biggest pool of assets and have very flexible charts for this particular task (overlaying tickers/assets), i have tested multiple other platforms which often fall short in one or many other areas.

The assets listed (attached) on the chart should be:


-SPY (SP500 as key equity index)

-US10Y (US 10 year bonds - TLTs)

-US05Y yields (yield on 5 year bonds)

-gold (XAUUSD or GLD or other tickers)

-Crude oil (optional)

-Dollar index (key currency index)

-VIX (optional)


The reason why crude oil is "optional" is because the impact on risk on/off from crude oil is often limited and confusing. While many would recommend adding commodity prices for risk on/off analysis (as they show the strength of demand within the economy) and crude oil is underlying for many commodities (due to the energy needed to extract them), the problem is lack of clarity in many situations, especially for non-seasoned market observers. At least from my observations. For seasoned market participants, it's perhaps more useful, and for someone less (for which this article is made) its perhaps better to avoid using it, at least initially. Anyway, just a quick explanation on why crude oil is not used on my charts. That doesnt mean oil shouldnt be part of risk on/off analysis, it just means it is bit more confusing and difficult to interpret its impact on daily basis. Might work for certain eye and might not for many others.


The reason why VIX is listed as "optional" is because it does not overlay with those assets well. Its volatility ratio is much bigger, and it skews the chart of everything else if it is added in same window (not sure if this applies to all platforms). I think that VIX should be part of risk on/off analysis but use it in separate charting window as i do as well.


Each asset should have a unique color and be represented with a line chart. Candlestick charts are always superior to line charts no matter what, however sometimes one cannot use them for practical reasons. Overlaying all of those assets with candlestick charts can make it harder to read and more confusing, which is why using the setup as outlined might be a better idea. The only ticker on the chart with actual candlestick action is SPY as you can see, and that is optional, it is not required.


To overlay assets in Tradingview in such manner, first select core asset and then click on plus to add all the rest assets into same window:



Relationships between key assets



Risk on/off analysis is mostly about the relationships between key (few) global assets and how their movements impact other assets within completely different asset class groups. For example, the impact of a gold price rally on stock prices, the impact of bond yields spiking on an equity index, the impact of a falling dollar on stock prices, etc...This is technique that most instituational participants are thought first. This is technique that most retailers either never look at, or do very very late into their journey (5 years plus).


This article focuses on the resulting relationship outcome from the perspective of equity markets, or specifically SPY itself. This is to simplify things and to make it more practical. But in the end, those relationships are not about equities themselves. One could take an approach in either direction. For example, how does a strong dollar impact bonds, how do weak bonds impact stocks, how do strong stocks impact gold, etc? There are many variations depending on what asset one wants to find the resolution clue about. But as said, the focus of this article is specifically on equity prices as in my estimation that is what most traders are interested in (and so does core of my daily activity in markets).


The first thing we should establish is that markets are a constant flow of money back and forth. From one asset class to another, and then back again at some point. It's a never-ending reshuffling of capital into the asset categories that make the most sense to be exposed to at a particular moment, from the eyes of market participants, but mostly the institutional investors or market making firms since those are the ones that ignite and move the asset prices the most.


Risk on/off analysis therefore is where one is looking at where the institutions are currently pushing capital into, or where they are pulling the capital out from. Into somewhere out of somewhere.


The relationship dynamic is the core of such analysis. I should point straight away, that the point of this article is to summarize and put the method in practical implementation for those without significant research or market experience. However, that includes not covering all the basics of key asset classes that one needs to understand before this analysis starts to make sense.

This means that for anyone taking this seriously, you should take some dive and research basics around each asset class (equities, dollar, gold, bonds, etc) because without covering foundations it will be harder to interpret the moves on a daily basis. If you are serious about it, make sure you take a month and do some research into each asset class. The reason why this should be highlighted is that I know how asset-focused (asset racist is that a term?) many traders are. For risk on/off you must spread the wings and be open-minded and curious to check all of those places out.



Stop guessing whats moving the market and look at money flows of risk-on/off profile



  Combining the market outlook through key asset classes always leads to more clues, rather than trying to make sense of one market class through the lens of that (and only that) asset class (which is always leaving you with blind spots). Why is SPY rallying? It has to be because crazy algos are buying it. This would be a common rationale of single-asset-focused traders. If you look and zoom out enough you might notice the dollar has weakened, and that market is bidding on many riskier assets at once while exiting cash positions or exiting safer assets (bonds, dollar, etc). And often that will leave a much better clue than guessing with strange assumptions about "irrational algos". Most "crazy" assumptions are typically those who never bother seeking for proper in-depth explanations. 


 As mentioned earlier in the article, one of the main reasons why so few traders apply this to their trading (which is highly useful to have explanations on why the moves in markets happen the way they do) is because they have only an interest in a single asset niche. Risk on/off is the inverse of that and requires one to venture with interest and curiosity into multiple assets.


That does NOT mean one is trading all of those assets to be completely clear, it means that one studies and researches them so that relationship dynamics are clear. Even if one is only trading SPY or large caps, it is very useful to know that today might not be the day to go long, based on how the risk on/off flows are positioned. And extract any of the suggestions made for SPY trading to be the same as for large caps, because this is all about the trickle-down effect of markets:


-bonds-currency-equity index-large cap stocks-smallcap stocks. 


It starts with bonds, and it ends with small caps. The entire chain of assets as you see them listed above influences one another, and the money flows that institutional capital is shifting from one place to another based on changed daily dynamics of markets.


-Do you have a geopolitical escalation in the Middle East? Pull capital from smallcap and low-tier large caps and push it into bonds or currency. 


-Do you have a central bank announcing new QE and lowering interest rates? Pull capital from currency and push it into large caps and then small caps stocks. 


That is very roughly how institutions reposition based on changed daily dynamics, using two opposite examples. First one risk-off, second one risk-on.


If there is complete correlation, what is the usecase of such method?


Someone might say, but if the dollar goes down which causes SPY to go higher, isn't this an inverse relationship, and if such a relationship is highly correlated, meaning that instantly as the dollar plunges the SPY responds with exactly the inverse move of that...what is the use case then? Keep in mind, that 100% correlations with the same timing are not useful in markets because one asset is telling you the same story as the other asset, even if they are inverse of each other. Luckily that is not the entire story, so let's break it down how one should think about it.


Think of it as a supportive, or unsupportive environment for stocks. Are we currently in an environment that is supportive of higher prices in equities? Or not?


But don't think about it only in terms of correlation, think also about the long term DRAG effect. What is meant by that, is if the dollar is trending higher consistently day by day, that is not a very supportive environment for stocks. This means that it is possible the equities will struggle to make new highs or might be declining if dollar keeps ramping higher. Sometimes, equities will go higher when the USD goes higher at the same time. But the DRAG effect of the strong dollar will eventually top out equities and send them lower. This is a drag effect, which is not necessarily 1:1 on inverse correlation. So always look from the perspective of a supportive or unsupportive environment, because that can lead to more realistic targets on where the equities should go next over mid-term perspective.

Let us outline this in conceptual example:



Risk on/off analysis is NOT static (be adaptive)




If we lean on the point above, why should one think about the "constant flow of money" in markets? Because risk on/off analysis should not be used as a static method. It is highly dynamic, which requires constant adaptation and 0 "set and forget" bias.

The flows can change at any time. They can change in opposite directions completely, and sometimes when they do, the asset classes will begin trending for weeks in that newly established direction. This means that it is incompatible with thinking about this approach in static terms. Mostly it's because of duration exposure differences.


For example, sometimes risk-on kicks in and lasts for 3 weeks. Which gives one smooth trend to follow (to trade large caps on long side for example). In other cases, it only lasts for a few days before risk-off kicks in again and inverses the flows. Because of these different durations of how long those risk on/off cycles last (with significant differences in days of durations) one HAS to be dynamic about adjustments. This brings us to the point above on why using two-time frames to establish bias as well.


Different lengths in cycle durations

So the point about being dynamic with method is that sometimes the cycle lasts 3 days. And sometimes for 30 days. There is a big differentiation in exposure length between 3 and 30, which requires us to expect any duration. Hence, being sensitive to short-term changes is ideal, because one doesn't know if this newly established cycle is going to last shortly (and require one to adjust again with new bias) or if it will establish a long-lasting cycle (which makes for a good trend-extraction plays without worrying about short term changes too much). It could be either or, and you don't know which one exactly the market has for you upcoming.


By static analysis, I mean for example that some traders make an analysis one month in advance for a particular stock and then they stick to that and make trading plans around it. In risk on/off no plan should ever be considered a long-term (1 month) plan in advance unless one knows well what they are doing. It is healthier to be as adaptive as possible and adjust to the flow changes daily. Not weekly, not monthly, but daily, or perhaps even hourly. That ensures the lowest chances of getting bagged and overstaying positions. Do you know why so many traders get bagged on top of cycles? Because they do not pay attention to changed dynamics of risk on/off sentiment. Overstaying is likely if you don't pay attention to this.

Example on image below is very short lasting risk-on cycle. Those cycles happen from time to time. It is falacy to believe that each time new risk-on/off cycle ignites that it has to last for month or two. In more than half of the cases it ends much sooner.



And to have counter-punch to above example, below is the longer lasting risk-on cycle example:




The above two examples should give you a firm conclusion on why adaptation to those flows is required and why being nimble on a daily basis is a good thing.


Keep in mind however also a statistical factor that:


-It is not highly likely that within the single intraday session flows would go strongly from risk-off to risk-on.


-It is also not very likely that on any random day, you would see flows shifting from risk-off to risk-on without the support of a major catalyst.


This means that IF flows were to inverse strongly it's highly likely it happens on the day of some major catalyst. CPI report, FOMC meeting, central bank monetary policy changes, and similar high-impact economic news.

Should one pay attention to news and how the market reacts to it? Of course. Again, it's not that your interpretation of news that matters. It's market interpretation and money flow, and what it does to potentially change risk on/off sentiment. Your task is not to question the market's reaction (which is what many pundits in markets do), as a trader your task is to follow the newly established direction of money flows until it lasts.

Before you question the flows, trust them.



Remember that academics can afford to always be skeptical and doubt every move of a market. As a practictioner trader or investor you cannot operate like that. So before you question things, trust the flow. Questioning the flows is actually a very advanced concept and it takes a significantly experienced person to do it well (most that question it will get on the wrong side of the market for a prolonged period of time, which as a trader you cannot afford).


How often to check on the flows?


My approach is to do 3 checks across each day and re-assessing the flows. One in pre-market, one around market open, and another one in the middle of the day. Sometimes that schedule changes if there is an important news catalyst, but typically that routine stays the same. You don't have to spend much time on that, once you are familiar with the concept. It takes a small amount of daily input on track, and the return on understanding where money flows are going on a daily basis has significant advantages no matter what asset class one is trading. Low time consumption (except the time invested into learning about the method), and high-value output for bais formation. On a typical day, it takes about 5 minutes in total to asses the flows.

Dont try to interpret the news (unless you know what you are doing well), interpret the money flows instead

Many times in markets it's difficult to figure out what the catalyst means and whether the market should take it as positive or negative. Many times what seems to be a positive catalyst ends up being a negative reaction in markets, for many reasons.


Risk on/off analysis can help the trader to figure out not what the interpretation of catalyst is, but to figure out what the market (mostly institutions) is doing with their capital on the release of catalyst. Are they bidding on it or selling it. This makes it much more practical for traders to figure out what the key market participants (biggest ones) think and which direction might be the one to play in. Not using risk on/off around key news events is definitely trading with at least a third of the less open-eyed vision that one needs in markets.


For example, it is very common that on FED minutes traders try to read every article or read every comment from the FED chairman and try to interpret what this should mean for market direction next.

Only few (retail participants) check all key assets (USD, SPY, gold, bonds...) to make up the view of how the biggest market participants interpreted the news. Which is the most important thing. Your interpretation of the catalyst is always lesser than one of the biggest market participants (those that shape risk on/off flows in ignition phases). So traders and investors spend way too much time on interpretations of catalysts and too little on interpreting market action and how they bind to risk on/off. This leads to subjective opinions at too high a rate. Money flow interpretations are far more strict and direct with less subjectivity. Which is exactly what you want as a market participant.

To validate point above lets use an example of US CPI news release on November 14th:




As we can see, the market reaction was significant to the catalyst, even though on face value catalyst is very weak? Slightly positive because the inflation came lower than expected, which in the era of elevated inflation is good news. However, it was only a slight beat over the expectations.

One might assume that this type of news can only deliver a very soft and small positive reaction. Yet it was completely the opposite. This catalyst delivered the strongest risk-on reaction in almost an entire year.

Now think about it, have there been much more bullish catalysts over the year of 2023 that would justify more such move as we got on November the 14th? Sure. A few if not more. But that is not the point.

Trust the money flows first (if you are trading markets on a short term basis) before you start to question the validity of news. This especially is true for anyone trading short term, which assumes most of readers will be. As one can see from the chart above of SPY, market went into significant risk-on mode with solid uptrend on equities.


Risk ON/OFF analysis is how one survives in markets. Experienced market participants still get in trouble because of not understand the risk profile analysis (once their favorable market conditions shift).



Typically traders who are ignoring this concept in markets and are fully single asset-focused will eventually land in a market where for 2,3 or more years market becomes dominated by major changes in risk on/off flows. And when it starts to happen it usually takes long time for people to figure out whats going on, mainly because of lack of understanding on risk-profile analysis (and because they are so much single-asset focused).

Especially small-caps equities and crypto fellas tend to fit that the most. If I am a crypto anarcho-capitalist or smallcap moon pumper surely I don't have to pay attention to risk on/off flows? Well turns out you do have to. The amount and quality of opportunities are highly correlated to global market liquidity. And global market liquidity is derived and ignited from risk on/off changes!


To put it this way using two different years:


-2020: The amount of high-quality long opportunities in both small-caps and crypto was highly correlated to the major risk-on flows ignition in late 2020. If you ever wonder why there was such a rush in both of those markets that year, it is due to that.


-2022: The situation was upside down. Risk-off began and the number of quality opportunities shrank significantly, making it more difficult for everyone.


In each case, risk-on/off ignitions were noticeable early if one knew what to track. So this isn't about hindsight analysis. We don't need to go beyond those two years as clear pro-contra examples of just how important this is.


Both years outlined in high time frame risk on/off assesment:




Dont half-ass risk profile analysis just by watching SPY (highly common and sloppy)




If you only watch SPY and nothing but SPY (besides a bunch of large caps that you might trade), then how do you explain yourself when SPY just rallied 5% in a short amount of time, without looking at the whole capital redistribution game of risk on/off flows? This is why such ridiculous statements in social media often come up "SPY algos are crazy buying for no reason" or "SPY just moved way too much on weak news" etc...

That kind of statement typically shows that people do not pay attention to global asset classes as a whole, to understand why certain moves in the market happen the way they do.


Remember that your asset class of focus does NOT provide always the answers of whats going on in markets, or what the biggest stories are. Often those things happen outside of your focus niche. And many times its very valuable to know why and what is happening as that will eventually impact risk profile for global liquidity.


Many times SPY will rally big time, and it's not because someone just turns algos up randomly but because key institutions started to push capital in all risk-on assets at the same time. So it is not SPY only that is moving, but the entire chain of risk-on assets, which then feeds into the move of SPY. Tick by tick. One tick-up on bonds leads to one tick-up in SPY. Leads to one tick-up in Russell2000. And then tick by tick one asset class influences the other. Assets are priced on a tick-by-tick basis within the context of what other assets are doing. Always remember that.


Risk-ON November


Do you think it's random that small-caps had a large amount of multiday runners in November and a relatively good amount of action, at the same time as alt-coints within the crypto space ignited too? And not to mention even OTC stocks started to move in November after being in total hibernation for months if not years. Random? No. Risk-on and a strong one explains it. So no matter what asset class you have selected, you have been impacted by behavior change.

Charts below to highlight point above:

Risk-on November from perspective of big markets:


Risk-on November from perspective of smallcap multiday-runner ignition:


Risk-on November from perspective of big crypto alt-coins:


If you do track multiple markets and asset classes, one can build stronger view on whats happening and why, and always be more inline with reality to those who focus only on single asset class at all times. However, it does take some time to study each asset class at least on the basics before it can be implemented into risk-profile analysis well.


The reason why outlining the "survival aspect" of this analysis is because, if all one has is to speculate why things are moving the way they are (without understanding money flows), that will eventually lead to troubles because it opens up too big room of self-interpretation and subjectivity.

Risk on/off explains what the big guys in markets are doing, where those greenbacks are flowing towards. You can't see in their head (of those large participants, and their reasons), but you can see into their wallet because the wallet is speaking with the way assets are getting a bid.



Volatility matters




It is not just about the directional moves that matter, but the scale of volatility that adds to a score of risk on/off analysis. High volatile moves of X asset (lets say dollar) add more to the score of risk on/off flows than low volatile move does.

For example move upwards in bond yields could be seen as bearish, but it depends on what magnitude. A high volatile move (using the past 30 days as context) is much more bearish than a low volatile move. This is why one should always have the context of the move in mind to see what kind of contribution it has to the entire bias.

So always have the 30 day and 5 day context in your mind, to understand what kind of magnitude of change in current assets you are observing. Relative volatility and then current change in volatiliy is what matters.


The general rule is, that the more volatile the moves and the more cleanly aligned in the same direction the better. For example, the ideal risk-on ignition version is:

-strongest move in the dollar to the downside in past 30 days

-strongest move in bond yields to the downside in the past 30 days

-strongest move in SPY to the upside in the past 30 days


If all above happens at the same time, that is a high volatility move and all aligned on the risk-ON (all assets agree on same direction). Which is ideal as it doesn't leave us confused.


Sometimes the movements will not be as clean and one asset class will divert in different direction (for multiple hidden or obvious reasons), for example more confusing risk-on situation (less ideal):

-dollar lower

-bond yields lower

-SPY flat or lower


The above would be an example of a more mixed situation, where one or more asset classes do not agree with risk-on. Especially if the volatility of each asset moves is not big, it's best to be careful about making any firm conclusions in such case.


In some cycles all assets will agree firmly, which is more often than not. But sometimes there will be more confusing mixture.


To use example of November and context of volatility and why that was such strong risk-on ignition from perspective of bond yields:


Priority of asset classes

Important point to establish, which of those asset classes is most important, or contributes to risk on/off analysis the most? The answer is not static, however there are certain dynamics that usually take place. But sometimes priorities change. It depends on the situation. Overall we could say (and from a personal view) that it's somewhat equal, but on some days there is one asset that will take a higher lead. This requires a very long explanation to get it right, so just take it as a starting point to consider all key assets listed on article as equal. They are not always equal as said, but to explain those situations historically well it is whole another article in itself. For the starting point, it's good to balance the input of each asset class into risk on/off analysis as balanced with equal weight.

If one has 5 assets in total, then each represents 20% of the total view. In other words, the meaningfulness of the bond move is equal to SPY. As said, if we were to dig into details it's not that simple, but roughly speaking it's the good starting point to use on a daily basis (and then re-calibrate better with more experience).


Some examples of risk on/off ignitions (on ignition day)



Risk-OFF example that established solid intraday reaction with followup over next few days:



Risk-OFF example that established solid intraday reaction with followup over next few days (wrong notation on chart):



Risk-ON example:



Risk-ON example:



Many of the above ignitions are on catalyst days of major news releases, but not all. Because there is so much news on a daily basis hitting the markets it can get very confusing tracking everything and trying to interpret which news article might matter and which might not and the market will ignore it.


It is far better to just focus on risk-profile analysis and then check when flows react strongly. You will know which news event the market had a sensitive reaction to, and it's likely that this catalyst will impact the market going further. Too many news releases just get ignored by market (short term no market reaction), and can quickly clog market participants with too much noise. Using risk on/off is a filter that helps you with that to isolate news that matter the most.


This makes prioritization of risk profile first, and news interpretation second. Especially since interpreting news is much more difficult often than it is to interpret what the big money is doing and where the flows are going (assets responding will tell the story).

Conclusion



We have highlighted some of the relationships between key assets and how to practically implement them into daily analysis.

What this article does not cover is the basics about what each of those asset classes represents. What is its function, why the global economy needs them, and so forth?


It is expected of the reader that this is studied to make sense of the things said above. For example, why are rising yields bad for the economy and the performance of equities? Why is the rising dollar not ideal for equities or commodities and how that might translate into SPY and so forth?


It is required to study each asset class on its own, cover some ground, and then risk profile analysis will make much more sense. But buckle your seatbelt because it isn't a quick task especially if you are new to this.


As mentioned in the article above, if one is serious about surviving in the market it is required to study those assets and how they tie in global market flows.

This analysis is what makes one defensive when it's time to be defensive because the market just went into risk-off.

And it's this analysis that gives one conviction to step up the risk exposure when risk-on kicks in, by placing more long trades and being more patient (aka greedy) for larger moves.


Source material to study the basics of each asset class is not listed, because there is plenty of free material about this everywhere (if you focus study into each asset class on its own). Just make sure you do not pick subjective opinions when you study. Pick sources from those who strictly talk about the functionality of each asset class, rather than what the assets are supposed to do. Economic books (macro economy) tend to cover this quite well, you can grab bunch in your local library possibly. Your read on risk profile analysis needs to be built on top of objective info, not subjective views. So the focus is functionality when it comes to basics.

6 comments

6 Comments


breevans
Dec 09, 2023

This is one of the best trading articles I've ever read - thank you! For your TradingView charts, are you setting each line to No Scale?

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Jan
Jan
Dec 09, 2023
Replying to

Pinned to right scale. First one.

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Κώστας Ζαμπετάκης
Κώστας Ζαμπετάκης
Dec 05, 2023

Any specific reason why you have 5y yield in the chart and not 10y yield? Why dont have 10y bond along with its yield. They are highly correlated but i am curious to know

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Jan
Jan
Dec 06, 2023
Replying to

There is high correlation between the two. You can use 10y yield as well. 5y is bit more sensitive to quick changes and for intraday analysis that's one of bigger reasons why I use it above 10y. But you can't go wrong with using 10y yield it will just have more mid term sensitivity rather than short term.

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