What Are Cyclical Stocks?
Investors are constantly looking for ways to increase their profits by boosting their strategy and diversifying their portfolio. Cyclical stock investments are often one of the best solutions for acquiring optimized returns.
Whether you’re an experienced investor looking to explore a new market or a stock market beginner, it doesn’t matter. This guide will help you learn how cyclical stocks work and help you discover the best ways to use them in your investment journey.
Definition of a Cyclical Stock
A cyclical stock is a stock linked to a business that is likely to see its sales figures experience peaks and troughs throughout the year in alignment with the economic cycles of recessions and expansions.
Any company that is considered to fall under this category is expected to enjoy an excellent performance during times of economic growth but will be equally susceptible to downturns when the economy falters.
Examples of Cyclical Stocks
While companies under this category can be found in most sectors, some industries are more likely to have examples of firms that follow the business cycle. Firstly, though, one must understand the cyclical nature of supply and demand.
In short, economic booms drive people to spend money in a more optimistic style, often manifesting in the increased purchase of luxury items that wouldn’t be purchased during a recession. Any business that provides this type of consumer goods is likely to have cyclical stocks.
Common industries considered cyclical include restaurants, hospitality, entertainment, fashion, cars, travel, and home improvement. Essentially, they sell products people can live without if necessary. The cyclical rise and fall of demand for the products will subsequently be reflected by the stock market.
Cyclical vs. Noncyclical Stocks
Not all stocks are cyclical. Noncyclical stocks are from companies whose performance levels don’t follow the same pattern as the business cycle. Noncyclical businesses include producing and selling food, cleaning products, gasoline, and so forth. People continue to buy these products regardless of circumstances.
Naturally, though, the sales volume is unlikely to soar during economic upturns.
Essentially, noncyclicals can be thought of as businesses and products that are less impacted by the economic status of consumers. They are often referred to as defensive stocks due to the lack of volatility surrounding them. In some cases, they even see growth during times of economic hardships.
For example, Walmart often reports improved returns as people actively seek to save money on essentials.
In the most basic terms, then, the difference between cyclical stocks vs. noncyclical stocks is defined as the contrast between products that people want (cyclicals) and need (noncyclicals). This information can subsequently help investors develop a robust stock market strategy.
The Advantages of Cyclical Stocks
When choosing an investment strategy, it’s vital to ensure that you start in the right industries. Selecting businesses that move with the economy can offer a wide range of benefits:
- Investors who time it well can trade in and out in line with the highs and lows of the economy. Accurate forecasts can subsequently lead to rapid growth.
- Items that fall under this category are easily identified because they are the products that people want rather than need.
- The possible returns are higher than the less volatile noncyclical stocks, which naturally attracts a lot of users.
- Once you have become experienced and understand the business cycle and how it impacts this type of company, cyclicals become slightly easier to predict.
- In many cases, the times to buy and sell will be the same across all cyclicals. With other stocks, it can be a more stock-by-stock decision.
New investors choose this path every single day.
The Disadvantages of Cyclical Stocks
Cyclicals come with some risks, too. Every responsible trader should be equally eager to understand these as the advantages. Some key issues to consider are:
- While the growth can be rapid, the potential losses in recessions can hit you harder, too.
- Profits are often uncertain. The products made by the companies in these fields are usually luxuries. If new items enter the market, competitors could quickly suffer.
- Any opportunities to earn significant capital gains may be severely limited during recessions, which restricts your possible timescales.
No investment strategy is perfect, as these points prove. Still, the advantages can easily outweigh the downsides.
How Can Investors Get Involved With Cyclical Stocks?
The first question you’ll have asked is simply: What are cyclical stocks? However, understanding stocks and shares in relation to the business cycle counts for nothing if you don’t know how to invest in them.
The short answer is that the process of buying cyclical stocks is the same as buying any other stock. Cyclicals and noncyclicals both appear on exchanges like the New York Stock Exchange. Most investors, especially beginners, will start their process by finding a good online broker platform.
The exact procedure may vary slightly, but most investors will follow these steps:
- Register for an account with an online broker, verifying one’s identity in the process.
- Deposit money so that the exchange can be used to hold stocks and shares.
- Start trading by buying cyclical and noncyclical stocks to suit one’s demands.
The great thing about online broker services is that you can track the price of any asset in real time. Moreover, traders can use advanced tools to automate the process. This can reduce the exposure to potential losses and save you time.
Regardless of what stocks you invest in or trade, you’ll be expected to pay taxes on any positive returns. So, before making any commitment, it would be wise to research this subject and how it’ll impact your overall portfolio growth.
Choosing Which Cyclicals To Buy and Sell
Understanding when to focus on stocks that fall into the category of cyclical stocks will increase the likelihood of seeing positive results from your investments. Nonetheless, you’ll need to find the right opportunities within the market at any given time, too.
If it were as easy as backing companies that sell luxury goods as soon as the economy takes an upturn, everyone would be doing it.
For starters, you’ll want to confirm that the economy is still moving in the right direction and that you haven’t missed the boat. Otherwise, you may incur losses within days of buying your shares.
The pandemic caused a major downturn, but the economy is recovering. Investors should focus on the industries that are most likely to experience a boost that lasts for several months.
Airlines, entertainment companies, and hotels should all see positive results, but it’s important to research which individual businesses people flock to. Tracking relevant news developments will be necessary, too.
The other big decisions you’ll need to make revolve around the amount of money you want to invest, as well as the order type. Deciding the number of shares (which can also be a part of a share) should be influenced by your portfolio size, budget, and general strategy.
If you are holding cyclical stocks through the downturns as well as periods of growth, your habits will be different.
A standard order will be a “bid,” which is when you buy the shares for the set price before manually deciding when to trade out at a later date. You’ll also want to research the following terms:
- Market order
- Limit order,
- Stop-loss order
- Stop-limit order
When you make the right decision over the asset and the type of order, your investments will look stronger.
The Bottom Line
Cyclical stocks are popular with investors from an array of backgrounds, not least because they offer the opportunity to deliver quick growth. The risks do mean you’ll have to pay even more diligence during the research phases and keep a close eye on all developments. Nonetheless, stunning results can be seen by day traders and long-term holders alike.
I have always thought of myself as a writer, but I began my career as a data operator with a large fintech firm. This position proved invaluable for learning how banks and other financial institutions operate. Daily correspondence with banking experts gave me insight into the systems and policies that power the economy. When I got the chance to translate my experience into words, I gladly joined the smart, enthusiastic Fortunly team.
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