CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 78.1% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
US English

Trading stocks during a recession: What you need to know

By Jenal Mehta


Updated

Trader watches a chart showing tumbling share prices
How can traders navigate economic downturns? – Photo: Getty Images

Although the global economy is not currently in recession, financial markets worldwide have been showing signs of its approach.

A recession generally implies that equity markets are in decline, and is accompanied by increased volatility. There are, however, ways in which investors can win during a recession.

A big part of that is understanding how the market behaves.

S&P 500 (US500) Price Chart

One key trend that investors could look at is that broader markets, as measured by indexes such as the S&P 500 (US500) and FTSE 100 (UK100), tend to fall much more sharply prior to a recession than within the recession period itself.

Defensive sectors such as utilities and consumer staples tend to outperform at such times, while technology and financials do not fare as well.

Investors also need to pay attention to economic policies, to gather intel on how long a recession may last.

What is your sentiment on US500?

5259.2
Bullish
or
Bearish
Vote to see Traders sentiment!

How do you know a recession has started?

Recession does not have an official definition, but it is most widely believed that a prolonged decline in real gross domestic product (GDP) means an economy is in recession. Most analysts and economists need this trend to occur for at least two consecutive quarters before they call a recession.

We are currently not in a recession. However, there are indications that we might be close to one.

Piero Cingari, an analyst at Capital.com, said: “Europe may face a recession sooner than the US due to the negative impacts of the Russian-Ukraine conflict. However, if the Federal Reserve is forced to boost rates quicker than expected in order to combat inflation, this might accelerate the risk of entering a recession for the US.”

Like any economic cycle, of course, recession is not permanent. For investors, estimating the length of a recession may be an useful tool in planning their investments. Cingari commented on the different variables to watch out for

“Many variables affect the length of a recession, but the most crucial is inflation. If a potential recession coincides with a drop in inflation, governments and central banks may be able to respond by raising stimulus, thereby boosting the economy’s quick recovery.

“However, if inflation stays high even in the event of an upcoming recession, ie a stagflationary condition, then central banks won’t have the luxury of promoting interest rate cuts, therefore prolonging the recession,” he said.

FTSE 100 (UK100) Price Chart

How do equity markets behave?

The behaviour of equities varies, depending on the type of sector and the particular period of recession. Markets of course decline during a recession, as measured via indexes such as FTSE 100 (UK100) and S&P 500 (US500).

DE40

18,523.90 Price
-0.080% 1D Chg, %
Long position overnight fee -0.0221%
Short position overnight fee -0.0001%
Overnight fee time 21:00 (UTC)
Spread 1.5

US100

18,281.90 Price
0.000% 1D Chg, %
Long position overnight fee -0.0262%
Short position overnight fee 0.0040%
Overnight fee time 21:00 (UTC)
Spread 1.8

HK50

16,644.20 Price
+0.900% 1D Chg, %
Long position overnight fee -0.0233%
Short position overnight fee 0.0014%
Overnight fee time 21:00 (UTC)
Spread 30.0

J225

40,356.50 Price
-0.430% 1D Chg, %
Long position overnight fee -0.0110%
Short position overnight fee -0.0112%
Overnight fee time 21:00 (UTC)
Spread 10.0

However, research and analysis carried out by Darrow Wealth Management has shown that in the periods leading up to historic recessions, the markets declined much more sharply than during the recession itself.

When measuring recessions since 1953 they found that, on average, the S&P 500 (US500) lowered 1% during recessions, while in the six months before that the index dropped 2%, and in the 12 months prior to recession it dropped by 3%.

 

Which sectors outperform during a recession?

Within equity markets, the behaviour of different sectors varies.

Cingari spoke about which sectors tend to outperform, saying “in a recession, consumer staples and utilities often fare well.”

Defensive sectors such as consumer staples and utilities, as well as telecommunications and healthcare, tend to outperform during this period as consumers do not cease spending on these necessary items. Thus, these companies can protect their profitability, and so the value of these sectors tends to decline less than others.

Cingari explains: “People cut back on leisure and put off buying a new car when they wish to save more money and limit their budgets. They do, however, keep paying their bills and continue drinking Coca-Cola (KO)”

As for poorly performing industries, Cingari says the recovery period of these sectors depends on what economic policies are in place.

“If rate cuts and fiscal stimulus are implemented, sectors that have performed poorly, such as technology and cyclical goods, will swiftly rebound. However, if stagflation is a possibility, the recovery of the most affected industries might take considerably longer than expected.”

Many investors also head for safe havens during a recession.

How can investors make the most of this?

There are many potential options for investors to make the most of a recessive market.

Depending on how long the recession lasts for, there several different strategies investors could follow.

  • Go short: the short-term investor can make most of the recessive market by selling forward. With research, the investor can make the most of the sharp decline, especially of those sectors which are expected to underperform, such as technology and real estate.
  • Make a post-recession plan: the market will not stay this way for long, so looking at strategies to make the most of market growth post-recession is also a consideration.
  • Hedge: an investor can use both long and short positions to navigate the market. The investor also has options to hedge using positions in two different equity sectors.

Markets in this article

KO
Coca-Cola Co (Extended Hours)
61.16 USD
-0.01 -0.020%
UK100
UK 100
7976.5 USD
29.2 +0.370%
US500
US 500
5259.2 USD
9 +0.170%

Rate this article

Related reading

The difference between trading assets and CFDs
The main difference between CFD trading and trading assets, such as commodities and stocks, is that you don’t own the underlying asset when you trade on a CFD.
You can still benefit if the market moves in your favour, or make a loss if it moves against you. However, with traditional trading you enter a contract to exchange the legal ownership of the individual shares or the commodities for money, and you own this until you sell it again.
CFDs are leveraged products, which means that you only need to deposit a percentage of the full value of the CFD trade in order to open a position. But with traditional trading, you buy the assets for the full amount. In the UK, there is no stamp duty on CFD trading, but there is when you buy stocks, for example.
CFDs attract overnight costs to hold the trades (unless you use 1-1 leverage), which makes them more suited to short-term trading opportunities. Stocks and commodities are more normally bought and held for longer. You might also pay a broker commission or fees when buying and selling assets direct and you’d need somewhere to store them safely.
Capital Com is an execution-only service provider. The material provided in this article is for information purposes only and should not be understood as investment advice. Any opinion that may be provided on this page does not constitute a recommendation by Capital Com or its agents and has not been prepared in accordance with the legal requirements designed to promote investment research independence. While the information in this communication, or on which this communication is based, has been obtained from sources that Capital.com believes to be reliable and accurate, it has not undergone independent verification. No representation or warranty, whether expressed or implied, is made as to the accuracy or completeness of any information obtained from third parties. If you rely on the information on this page, then you do so entirely at your own risk.

Still looking for a broker you can trust?

Join the 580.000+ traders worldwide that chose to trade with Capital.com

1. Create & verify your account 2. Make your first deposit 3. You’re all set. Start trading