Cyclical stocks are linked to the current economic trend and tend to decline during a recession. They are found in industries where demand changes based on the economy, such as the automotive industry. Investors must accurately predict economic trends to create successful trading strategies.
Cyclical stocks are stocks that tend to move with the current economic trend. When the economy is growing, the share value of a cyclical stock will increase. During periods when the economy is experiencing some type of recession, the stock will decline. Cyclical stocks are typically associated with industries where there is a change in demand based on what is happening in the economy, rather than industries where demand tends to remain constant.
An example of an industry where cyclical stocks are found is the automotive industry. When the overall economy is growing, consumers have more disposable income and are more likely to buy new cars. This increase in consumer demand continues as long as economic growth continues. If the economy begins to stagnate and households no longer have as much disposable income as before, the end result is that demand for new vehicles declines, which in turn causes the value of stock issued by auto manufacturers to decline.
Cyclical stocks can also exist in specific sectors of various markets. During an economic downturn, consumers may buy less of a particular type of good while increasing their demand for other goods. This is true when it comes to food. When there is less disposable income, a household can buy less meat each week and use a portion of those savings to buy various types of beans as meat substitutes. In this scenario, the securities issued by companies that produce meat as their primary product supply will decrease slightly, due to the change in demand. Demand for beans as a meat replacement can create what is sometimes called a countercyclical stock build, as that build can be directly related to the economic downturn and consequent change in consumer buying habits.
It is important to note that investors do not have any control over the movement of cyclical stocks. This makes it all the more important to accurately project the direction in which the economy will move in both the short and long term. By doing so, it is possible to structure trading strategies that allow the investor to buy stocks that are likely to thrive in the coming months and years, while selling stocks that are likely to decline in value over the same period. Creating the right mix of buying and selling results in taking the economic trend to its obvious conclusion and increasing the potential for consistent returns.
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