How ETFs can give insight on market risk appetite

Strategy is important, but so are circumstances. As ETF expert Stoyan Bojinov points out in an article published on ETFdb.com, there is no one-size-fits-all trading strategy; success is affected by many factors, including risk appetite in the market.

“It pays to be aware of decreasing risk appetite levels in the market as this is likely to challenge many swing-trading and momentum-focused strategies; for instance, in a choppy market with weak risk appetite levels, it’s not uncommon to observe breakout trades failing quickly after triggering,” Bojinov says. “If you have a good sense of risk appetite levels, it could help your conviction on both entry and exit.”

With that in mind, he recommends several ways for traders to determine market risk appetite through information on ETFs:

• Stocks vs. bonds: the historical rule of thumb, which investors can still apply, is that if stocks are outperforming bonds, then risk appetite is probably strong. With that in mind, traders can try comparing equity ETFs and bond ETFs and see which ones are doing better overall.
• Check Index ETFs: If major indexes are trading significantly above their 200-day moving averages, it may be a signal of a prevailing bull market; conversely, trading performance below the 200-day moving average signals a bear market. Tracking the performance of index ETFs can give you a quick litmus indicator of market risk appetite.
• Emerging markets vs. developed markets: Are emerging-market ETFs currently stronger than those weighted towards developed markets? That may indicate a stronger tolerance for risk, though one would have to check if the trend applies broadly or is geography-specific.
• Sector-specific ETFs: Sometimes, it can be useful to read trends on a per-sector or per-industry basis. Cyclical sectors like consumer discretionary and technology sectors leading defensive ones such as utilities or staple commodities often characterize strong risk appetites.
• Safe havens: Consider monitoring safe havens like gold, long-term treasury bonds, or the US dollar. If ETFs that track these assets are picking up momentum, there is most likely a trend towards conservative trading, in which case it may be wise to minimize exposure to risky assets.

Investment trading is an industry where success greatly depends on adaptation. It is difficult for anyone to identify the best strategy to adopt, because strategies should be tweaked based on how the market is acting. There are many ways for traders to get their finger on the market’s pulse, and ETFs may be a vital point worth exploring.


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