How to trade during a recession

Talks of 'recession' raise red flags for investors and traders alike. As the world comes to grips with the ripple effect of Covid-19 and global headwinds wreak havoc with consumer behaviour, it pays to stay one step ahead when markets dip.

Learn more about what a recession is, how to manage your investments positions, and how to trade a down-trending market.

What is a recession?

A recession is a period of slow economic growth. It’s recognised technically as a period of two consecutive quarters of negative growth in real gross domestic product (GDP).

Equity markets will generally take a hit during this time. You can often see its effect in reduced household and business expenditure, reduced demand for debt, and a rise in unemployment.

How does a recession impact markets?

Equity markets tend to decline rapidly during a recession. Currencies are volatile, commodity prices fluctuate, and the investor sentiment is low.

Most investors and companies tend to be risk averse. Investors will pivot from riskier assets—think cryptocurrencies and Information Technology—to safer ones as such as bonds, gold and consumer staples. This sees risk asset prices drop and performance rise for asset classes with lower but stable returns, having less reliance on economic cycles.

Sectors resistant to a recession

• Healthcare

• Consumer staples (food, beverage, household goods)

• Utilities

Sectors vulnerable to a recession

• Technology

• Financials

• Consumer discretionary (apparel, leisure, automotive)

Stocks and sectors to watch

Diversifying your portfolio is one way to stay in the green as markets fluctuate over time. Spread your risk across a variety of share types for the best chance to navigate bumpy markets successfully.

Defensive stocks

These tend to weather economic cycles well because they resist the changes in consumer demand that comes with a recession. You’ll find them in industries considered “necessary” in any economic event, offering goods and services we always need. They offer stability and consistent dividends with low capital growth.

Blue chip stocks

Blue chip stocks have generally seen it all in terms of economic cycles. They hail from large corporations that are well-established, financially stable and market leading.

They often have dependable earnings with solid financials and stability including consistent dividends. They’re considered a low-risk/highly reliable option for investors.

Growth stocks

These are shares with significant growth potential. Investors generally buy them for capital growth, not dividends. Growth stocks typically don’t pay dividends to investors as they reinvest their profits back into company development.

Growth stocks tend not to fare well during a recession because they strongly rely on high product demand from consumers and estimated future cash flows.

Cyclical stocks

Cyclical stocks are sensitive to economic change. They tend to dip in value during a recession due to reduced consumer demand, but they also offer an opportunity to buy undervalued stocks. That’s because investors will often look to sell these stocks during a recession, out of fear or profit taking, providing an opportunity for new investors to enter these markets.

What not to do in a recession

Predict the bottom. Nobody knows when the market will pivot. Don’t get caught trying to time the market with fear of missing out. Time in the market is more important than timing the market.

Panic sell. Don’t let your emotions take control of investing decisions. Keep the general economic cycle in mind and the reasons behind your initial investment. Consider all your options, have confidence/conviction in your research and let the company ride the economic wave.

Get caught in the white noise. It’s not uncommon for investors to turn to short-term speculation for quick profits. If you’re considering trading short-term price movements during a recession, ensure it suits your personal financial goals and you’re set with a strategy and understanding of the risks involved.

Trading during a recession

Discover market potential with the following trading strategies.

1. Dollar-cost averaging

   Consider investing certain amounts of money at incremental intervals instead of keeping all your eggs in one basket (at one price). As the share price falls, you buy more equity, reducing the average buy price of the share over time. Always do your research to make sure there’s future growth in your chosen share.

2. Exchange Traded Funds (ETFs)

   Exchange Traded Funds (ETFs) are a basket of securities or pooled investment vehicles that typically track a particular index, commodity, sector or asset. You can partially own an ETF, providing you with diversified exposure to the basket of assets in that ETF without actually owning the whole underlying assets like shares.

3. Options trading

   ConsiderPay a premium for the right, but not obligation, to buy or sell shares at a specific price or on/by a specific date. Options trading is like a form of insurance should the market not work in your favour.

   However, options contracts, especially short options positions, carry different risks than shares and are often intended for more experienced investors, for example, margins and expires. learn more

4. Share CFD trading

   CFD trading is fast-moving, the higher volatility creates both risks and opportunities.

   Trade rising and falling markets with Share CFDs. By taking a short position on the price movement of a share, you can potentially hedge the loss of a long-term investment without owning the underlying share.

   While CFDs offer an alternative to trading volatile markets where you can also profit from falling markets, they also present potential pitfalls. Investors should be aware of the significant risks, and costs associated with CFDs.

Risk warning:

This article provides general information only. It has been prepared without taking account of your objectives, financial situation or needs. It is not to be construed as a solicitation or an offer to buy or sell any financial instruments, or as a recommendation and/or investment advice. It does not intend to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any financial instruments. You should consider your objectives, financial situation and needs before acting on the information in this article.

Investing in CMC Markets financial products, including derivative products, carries significant risks and is not suitable for all investors. You do not own, or have any interest in, the underlying assets. We recommend that you seek independent advice and ensure you fully understand the risks involved before trading. Spreads may widen dependent on liquidity and market volatility. It's important for you to consider the relevant Product Disclosure Statement ('PDS') or Information Memorandum (for CMC Pro accounts) and any other relevant CMC Markets documents before you decide whether or not to acquire any of the financial products. Please also refer to our Target Market Determination for CFD products and Exchange Traded Options; Our Financial Services Guide (FSG) containing information about our services, including our fees and charges.