A Page From My 'Playbook' for Risk in the Markets

Editor's note: Investors are "playing offense"... not defense. And according to Pete Carmasino of our corporate affiliate Chaikin Analytics, that's critical information if you want to understand this market environment. In this article – which was recently published in the free Chaikin PowerFeed e-letter – he shares how to recognize the "risk on" mindset... and covers what it means for you.

Finding long-term success in the market is a lot like building a playbook in sports...

I don't relive my glory days often, but I excelled in athletics as a kid. And I played football in high school and college.

As I got to those levels, the competition was fierce. So it helped to have special skills...

I was fast. And I could jump very high for my height. At age 15, I was only about 5 feet, 7 inches tall – but I could grab the rim of a 10-foot, regulation-sized basketball hoop.

In my personal "playbook," I learned that I could disrupt the other team with my speed and jumping ability...

It didn't matter whether I was on offense or defense.

My glory days eventually ended. But when I entered the financial industry, I realized that the competition is just as fierce in the markets as it is in sports.

Speed matters... And so does the ability to jump from "risk on" to "risk off" assets.

That's especially important today – because right now, choosing one or the other could make or break your investment results. Here's what I mean...

First, let's define the terms.

"Risk on" is about being invested in growth stocks. These types of stocks inherently come with higher risk...

You're betting on future growth. It's not guaranteed to happen. But investors hope these riskier bets pay off. And they often do. That's when it pays to have a risk-on approach.

When it comes to Wall Street's playbook, a risk-on approach is like playing offense.

On the flip side, "risk off" is like playing defense. With a risk-on approach, investors are trying to "score" – or increase their profits. But a risk-off approach focuses on stopping or limiting losses.

Now that we're on the same page, here are my top three risk-on sectors...

  • Technology Select Sector SPDR Fund (XLK)
  • Communication Services Select Sector SPDR Fund (XLC)
  • Consumer Discretionary Select Sector SPDR Fund (XLY)

This play in my risk-on playbook consists of tracking the trends of these three sectors. These sectors are full of the growth stocks that investors turn to when they're willing to take on more risk.

It's like how a scout watches the next opponent of a college football team. The scout goes to the opponent's games to find the players that his team needs to focus on defending against.

In this case, I'm also always scouting against the benchmark S&P 500 Index using the SPDR S&P 500 Fund (SPY). That brings us to the three-paneled chart below...

Now, this chart looks more complex than a basic stock chart. But it's easy to understand...

The top panel shows XLK's ratio against SPY. That just means XLK is divided by SPY to form a ratio. When the ratio is moving up, XLK is outperforming SPY – and vice versa.

The same thing is true for the other two panels in the above chart, except they show the performance of XLC and XLY versus SPY.

By comparing these risk-on sectors against SPY, we can see that they're all currently in uptrends.

In other words... the offense is on the field right now.

When the offense is on the field, the defense often isn't – at least in finance. And when we look at a similar chart of three typical risk-off sectors, you can see that's true today...

The top panel shows the ratio of the Health Care Select Sector SPDR Fund (XLV) versus SPY. In the middle, it's the Consumer Staples Select Sector SPDR Fund (XLP). And the Utilities Select Sector SPDR Fund (XLU) is in the bottom panel.

These sectors are considered risk-off areas of the market because they're less about growth and more about safe returns. Since these sectors all deal with our everyday needs in one way or another, they're good places to shelter from a market storm.

As you can see, all three risk-off sectors are in obvious downtrends right now.

So our takeaway is clear...

Using my playbook for risk, it's obvious that investors are willing to take on more risk today. And they're not as concerned about playing defense.

But keep in mind...

When the risk-on approach is in an uptrend like right now, pullbacks can still occur. The difference is that you can view them as buying opportunities instead of reasons to get out.

Good investing,

Pete Carmasino

Editor's note: Back in January, Chaikin Analytics founder Marc Chaikin warned folks that a rare indicator was flashing... one that only triggers before volatile bull markets. We've seen those bumps in the road lately. The twist is, you can use a strategy that's specifically designed to capture "asymmetric results" in conditions exactly like these – by setting yourself up for potentially unlimited upside (and fixed downside risk) at the beginning of every trade... Get the details right here.

Further Reading

"'Mom and pop' have started paying attention to the boom in stocks," Brett Eversole writes. Everyday investors are getting interested again after last year's brutal decline. However, we're still a long way from peak sentiment – which means this bull market has room to run... Learn more here.

Not everyone is bullish today. Folks have been pouring money into "safe" bonds this year. This risk-off strategy might seem like a great move if you're worried about a crash. But it hasn't paid off in 2023... Read more here.