“What stocks should I invest in?” – This is a common question we hear from aspiring investors. There are many ways to determine profitable stocks. One of the most common strategies is by looking at the current state of the economy. Recognizing the kind of stock based on its relationship to the economy is an integral part of stock picking. In this article, we would talk about the difference of 2 kinds of stocks namely: cyclical and defensive stocks.
A cyclical stock is a type of security that is parallel to the trend of the economy. When the economy is in a recession, the profits of a cyclical company tend to drop as well. Conversely, when the economy is in a good state, the value of cyclical stocks tends to go up with the profit growth. These kinds of stocks are composed of securities that consumers can afford to buy more during a booming economy. These can also be synonymous to the word “luxuries”. A common example of this is an automobile company. A person may want to buy a car, but during a financial downturn, he would likely postpone his plans on buying a car, and spend money on basic necessities instead.
A defensive stock (also called non-cyclical stocks) is a type of security that either increases in value or at least maintains stable earnings regardless of the current state of the economy. These stocks are “basic necessities”. Common examples of these stocks household non-durable goods, health care products, food, beverages, and utilities. Even during an economic recession, consumers continue to patronize these products since they are part of the basic needs of a person.
Which investment is right for you?
Both of these stocks have their own advantages and disadvantages. Cyclical stocks tend to raise a lot in value in a booming economy, but they also decline drastically when the economy drops. Defensive stocks, on the other hand, are safe stocks even during a recession, but their price movement is very limited since they usually have a more stable trend.
Read about the importance of financial investing.
Knowing the different kinds of stocks is important. When the economy is in a positive trend, it is a smart move to invest in cyclical stocks as these can reach a very high value. However, when the economy starts to slack off, it is safe to switch to stable companies that produce things you can’t live without since we can expect that cyclical companies will be hit the hardest during those times.
It pays to keep an eye on the economic cycle and making smart moves in order to keep up with the trend. Investing in both cyclical and defensive stocks can also contribute to portfolio diversification. This technique can potentially help in hedging against the risks you might face. You can do this by investing only in industries that react similarly to changing market conditions.
Learn more about the hedging techniques to lower your investment risks.
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