Risk Aversion

Risk aversion is a term used by investors in financial markets, describing the behavior by traders to avoid exposure to uncertainty or risk.

The term contrasts with risk appetite, which reflects a trader's desire to increase their exposure to uncertainty or risk.

Risk aversion is a common trait of investors, who seek to hesitate towards investments with an unknown payoff or outcome.

These traders will opt for safer forms of investments that are either less volatile, have a more predictable outcome, and/or a lower expected payoff.

For example, a risk averse investor may opt for a certificate of deposit or bank account with a fixed but low interest rate, rather than investing in the stock or forex market.

Volatility is another factor impacting investors decisions.

When there are greater signs of volatility or uncertainty in markets, many investors move towards safe haven assets such as gold.

This is due to their stability as assets even in the face of high market volatility and uncertainty.

Risk Aversion Explained

Risk aversion can have widespread effects on markets. A risk averse or risk-off investor will also look to sell assets that are deemed less predictable.

This can include assets in emerging markets, volatile stocks, or specific currency pairs such as the NZD/USD and AUD/USD, among others.

Currencies that have relatively higher interest rates are regarded as higher-yielding currencies.

In the forex market, traders will actively unload their positions in higher-yielding assets and move their capital in favor of safe-haven currencies.

Safe haven currencies that are most popular in times of uncertainty are the US dollar, Japanese yen, and the Swiss franc.

These currencies are all considered safer due to the size of their large capital markets and liquidity.