Should One Invest in the Financial Markets During Economic Downturns?
Synopsis: An economic downturn does not mean investors should veer away from investing and trading in the financial markets. It is still possible to scoop profits during a recession.
Tumultuous economic times signal difficulties, but they do not mean that investing and trading in the financial markets have to stop. There will be instances when a pause is necessary, just like what happened when stock trading was halted
after the massive S&P 500 crash in March. Still, it is possible to turn in profits with the right investment and trading strategies.
Keeping cash creates exposure to inflationary risks
It is not uncommon for some investors to hold on to their funds when the economy is unpredictable and somewhat hostile. However, holding on to cash may not be a good idea. “A recession and volatile stock market can lead investors to keep their money in cash, but beware of lost time in the market and inflation,” as CNBC Markets’ Janet Alvarez aptly puts it.
Keeping cash provides protection from liquidity problems, but it can create exposure to inflationary risks. It also deprives investors of potential opportunities for profit. A study
by Robert Nason and Pankaj Patel published in the Journal of Business Research supports these ideas.
“Our results reveal that the nature of the curvilinear relationship between cash and market performance shifts from a diminishing returns curve before-recession to a more pronounced inverse U-shaped relationship during-recession,” writes the Nason and Patel study. In other words, the benefits of keeping cash decline at very high levels before an actual recession sets in. Meanwhile, the benefits tend to fall at medium levels during a recession. The study does not indicate improved benefits in keeping cash before and during a recession.
Investors who are looking for a good way to use their cash can turn to foreign exchange trading. Hugh Kimura of the long-running forex education site Trading Heroes offers compelling well-researched points
as to why forex trading is regarded as recession-proof. Essentially, what Kimura says is that currency trading is not that affected by recession because it allows trading with small position sizes and the ease of going long or short.
The good thing about forex trading is that there are platforms that make it even more accessible. As presented in a study
by Gainsky, for example, it is possible to trade in the forex market through a shared and crypto-forex collaborative platform. This kind of system provides an easy way to profit from the financial market by allowing the option to follow expert trading teams in the Gainsky Followtrade Model.
Key points in investing and trading
Recessions generally induce heightened risk aversion among investors. However, Certified Financial Planner Matthew Frankel of The Motley Fool says investing during a recession
can be an opportunity to grow one’s wealth, although this idea does not always work for everyone. Frankel specifically mentions three conditions that make it a good idea to invest even amid a troubled economy. They are as follows: (1) having ample emergency savings, (2) a commitment not to touch the investment portfolio for at least seven years, (3) not obsessing on monitoring the investment.
Frankel’s points make sense, but not many will be able to adhere with them. Retail investors in particular may find it difficult to put up a good enough emergency fund. Also, it may not be too sound an idea to commit most of what they have to investments that cannot access for a minimum of seven years. Even though the success rates are perceivably high, there is still no guarantee that the invested amounts would yield significant profits. Even if they turn in profits, it is uncertain if the amounts are worth the years of waiting.
As such, it is advisable to consider other strategies to find profits during a recession. Felix Hartmann, founder of the Hartmann Digital Assets Fund and a member of the Forbes Finance Council, lays out six keys for recession investing. These points share some ideas with Frankel’s “conditions.”
“While it is ideal to be ready before a crisis strikes, it is never too late to put a plan in motion,” Hartmann says. His analysis
can be summarized as follows: building the security foundation, playing the long game, investing in what is profitable, investing in what is future-proof, taking profits on extended relief rallies, and avoiding leverage.
Focus on the long-term, avoid speculations
As most experienced investors would advise, investing and trading in a recession should never be shortsighted. It is not wrong to watch out for relief movements that may arise in short intervals. These relief rallies can create market appreciation in the 10% to 30% range. Looking out for these opportunities is part of the long-term mindset.
What being shortsighted means is investing, for example, in stocks of companies that appear trendy and highly profitable at present but do not have good profit projections in the next ten or twenty years. It is about plucking bottoms to go all in and assuming that the bear market will not last for a long time.
Moreover, it is crucial to avoid speculative, cyclical, and leveraged businesses. These companies are associated with the highest risks of performing poorly in times of economic crises. As a Global Financial Data white paper
shows, government and private sector reactions to economic turmoil can create market bubbles, which can lead to speculative traps that adversely affect investors.
In summary, it is counterproductive to shun investing and trading completely during a recession. Investors holding on to their cash are not doing themselves a favor. There are opportunities worth undertaking with the right strategies and informed decision making.
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