FX Risk Regime (Risk-On - Risk-Off) - Composite

Overview

FX Risk Regime - Composite is a macro-driven regime detection indicator designed to classify market conditions into:

• Risk-On
  
• Risk-Off
  
• Neutral / Transitional
  

The model aggregates cross-asset information from equities, volatility, USD strength, and carry flows to generate a standardised composite risk score. It is particularly useful for FX traders who trade risk-sensitive and defensive currency pairs.

This indicator does not directly predict price direction. Instead, it identifies the prevailing macro regime so traders can align directional bias and risk management accordingly.

Conceptual Framework

Financial markets tend to rotate between two dominant macro states:

Risk-On

• Equities rising
  
• Volatility falling
  
• USD softening
  
• Carry trades performing
  

Capital flows into higher-beta currencies and growth-linked assets.

Risk-Off

• Equities declining
  
• Volatility rising
  
• USD strengthening
  
• Carry trades unwinding
  

Capital rotates into defensive currencies and safe-haven assets.

This indicator quantifies these dynamics and standardises them using Z-scores to create a normalised composite regime signal.

Indicator Architecture

The model is constructed using four cross-asset components:

1. Equity Momentum (SPX)
Symbol: SPX
Measures risk appetite via equity momentum
Positive equity momentum = Risk-On bias

2. Volatility Index (VIX)
Symbol: VIX
Standardised and inverted
Rising volatility = Risk-Off
Falling volatility = Risk-On

3. USD Index (DXY)
Symbol: DXY
USD strength is associated with defensive flows
Rising DXY = Risk-Off

4. Carry Proxy (AUDJPY)
Symbol: AUDJPY
High-beta FX pair representing global carry flows
Rising AUDJPY = Risk-On

Mathematical Construction

Each component is transformed using:

• Log momentum
  
• Rolling Z-Score normalisation
  
• Optional EMA smoothing
  

Composite Score:

RawScore = Z(SPX Momentum)
         + Z(−VIX)
         + Z(−DXY Momentum)
         + Z(AUDJPY Momentum)

The result is smoothed and compared to a configurable regime threshold.

Regime Classification

Green Background
Risk-On Regime (score > +threshold)

Red Background
Risk-Off Regime (score < −threshold)

Neutral Zone
Between thresholds — transitional conditions.

What Does the 0.8 Threshold Mean?

The default threshold (0.8) represents approximately:

0.8 standard deviations above or below the composite mean.

It filters out noise and avoids reacting to minor fluctuations.

Lower threshold - more signals, more sensitivity
Higher threshold - fewer signals, stronger conviction

For swing trading, values between 0.8 and 1.2 are typically appropriate.

How to Use This Indicator

1. Regime Filter for FX Trading

Use as a directional bias filter.

In Risk-On:

Favor:

• AUDJPY
  
• NZDJPY
  
• CADJPY
  
• EURAUD
  
• GBPJPY
  

Avoid:

• USDJPY shorts
  
• CHF strength trades
  

In Risk-Off:

Favor:

• USDJPY longs
  
• CHFJPY shorts
  
• EURJPY shorts
  
• AUDUSD shorts
  

Avoid:

• Carry longs
  

2. Position Sizing Tool

Increase size in aligned regime
Reduce exposure during neutral regime

3. Strategy Overlay

Combine with:

• Trend systems (EMA / MACD)
  
• Momentum systems
  
• Breakout systems
  
• Carry strategies
  

This indicator improves expectancy by preventing trades against macro flow.

Best Timeframes

Recommended:

1H
4H
Daily

Lower timeframes may be noisy because macro variables update at slower frequencies.

Asset Classes Where It Works Best

FX Pairs:
- JPY crosses
- Commodity currencies
- High beta crosses

Indices:
- DAX
- Nasdaq
- S&P500

Commodities:
- Oil
- Copper

Crypto:
- BTCUSD (during macro-correlated phases)

Strengths

• Cross-asset driven
  
• Macro consistent
  
• Quantitative standardization
  
• Regime persistence model (state memory)
  
• Adaptable threshold
  
• Fully transparent logic
  

Limitations

• Not a predictive model
  
• Reacts with slight lag
  
• May misclassify during structural regime shifts
  
• Dependent on external symbol data availability
  
• Regime changes can be violent. Use risk management.
  

Suggested Improvements (Advanced Users)

For advanced research:

• Weight components by historical Information Ratio
  
• Use dynamic thresholds based on rolling volatility
  
• Add bond yield spreads (US10Y vs JGB)
  
• Add credit spreads (CDX)
  
• Add copper/gold ratio
  

Customization

All major parameters are configurable:

• Z-Score Lookback
  
• Momentum Lookback
  
• Threshold
  
• Smoothing
  
• Symbols
  

This allows adaptation for:

• Short-term trading
  
• Swing trading
  
• Macro overlay models