Risk-averse traders and safe havens

Author: Forex Live | Category: Education

    A look at risk-averse investors

A risk-averse investor is an investor who prefers lower returns with higher certainty rather than higher returns with less certainty. Among various investments giving the same return with different level of risk, this investor always prefers the alternative with least risk.


What does Risk Aversion mean to traders?

If there is one certainty, it is that all traders face some level of risk when trading, as no trader can definitively predict the direction in which a market will move. Yes, Technical Analysis, coupled with an understanding of Fundamentals, can assist in confirming and suggesting entry and exit points, but there is always the possibility, no matter how much analysis is conducted, that the markets will move in the opposite direction to a trade.

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Risk is always there, with the more seasoned traders able to manage risk successfully by taking profits and cutting losses as they diligently stick to a trading plan or strategy.

So, if there is always risk involved in trading, how can a trader be risk-averse? Typically, markets are in a state of continual dynamic flux, reacting to supply, demand, economic data and so on. However, there are some instruments that traders will gravitate to in times of uncertainty. Typically called 'Safe Havens', they include Gold, the Swiss franc and the Japanese yen, which are particularly popular among risk-averse investors for a number of reasons.

Gold as Safe Haven

The value of Gold cannot be manipulated by interest rate decisions of a specific country. In addition, and as a physical asset, Gold retains its value by the fact that, unlike money, it cannot be printed and the levels of supply remain relatively stable. Thus, and as we hear more about global economic stimulus ending and recent interest rate hikes in North America and Europe, Gold emerges as an even more attractive investment. Traders turn to Gold during times of market volatility, with the price of Gold often increasing during extreme events or political developments such as the U.S.-North Korea tensions.

Japanese yen and the Swiss franc as Safe Haven currencies

The Japanese yen's status as a safe haven currency is driven, in part, by Japan's record debt levels. The value of foreign assets held by Japanese investors is substantially higher than the value of Japanese assets owned by foreign investors. Based on data from the Japanese Finance Ministry, these net foreign assets stood at an astonishing 349 trillion yen ($3.12 trillion) at the end of 2016! For the past 26 years, then, Japan has remained the largest creditor nation, while also emerging as a leader in terms of low-interest rates, keeping interest rates at extremely low levels for nearly two decades in its attempts to stave off deflation and spur economic growth.

The Swiss banking system, on the other hand, has been a time-honoured store of wealth for people from all over the world for their conservative thinking. Additionally, Switzerland has a long history of not defaulting on its debts. The country is considered politically stable with no major sweeping changes between regime changes. Unlike its European neighbours (France, Italy, Greece), Switzerland is socially very stable as well, with no fundamental problems that could cause unrest and affect its stability and wellbeing. As one of the few truly neutral countries in the world, Switzerland has not been involved in conflict in almost 200 years, which affords it very high standing among international peers and helps it protect itself against any threats to its sovereignty.

While there is always a degree of risk, the above three instruments are likely to always be in demand in times of uncertainty such as natural disasters, economic unrest and the threat of armed conflict (war). The next time you read about global tensions or a natural disaster, keep in mind that markets will become risk averse, displaying a risk-off sentiment that will most likely result in greater demand for safe havens.

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