A recession is a time of declining economic activity, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and sales. Businesses, investors, and government officials track these economic indicators to predict or confirm the onset of recessions, but specialized bodies officially declare them. In the U.S., this is the National Bureau of Economic Research (NBER).
How can I still profit from investing in stocks during a recession?
- You should focus on long-term gains. A recession brings about high market volatility, but this volatility usually occurs within a short period, and the economy and stock market usually recovers after the recession is over. If you invest for the long-term, you will not be affected by short-term market fluctuations. Avoid investing in high growth or speculative stocks as in times of high market volatility, you may stand to gain high returns, but you can incur high losses too.
- You should focus on diversifying your portfolio and investment strategies. Since market volatility is high during a recession, portfolio diversification helps to minimize risk and exposure by holding stocks that are either weakly or negatively correlated with one another. If you are holding on to a portfolio with stocks that have a strong positive correlation, you can try out different investment strategies such as long-short. For example, if you were to take up long positions on Apple and Amazon stocks when the recession hits, you can minimize your losses by shorting Tesla and Facebook stocks. Since all four stocks tend to move together, their prices will fall. However, your short positions on Tesla and Facebook will gain returns and can potentially cancel out losses incurred from holding Apple and Amazon stocks.
- You can purchase stock put options or short stock futures to lock in a specific price with the expectation that stock prices will fall during a recession. This way, when the option or future matures, you can sell the stocks at a higher strike price and repurchase them at a lower market price, effectively earning a profit. However, it is difficult to forecast when a recession will end, and if the stock markets rise above the strike price before your option or futures contract matures, you might incur losses.
- However, a period of economic recession does not always mean a downturn for the stock market. For example, during the economic recession in 2020 due to the COVID-19 pandemic, the stock market recovered rapidly following the crash that happened earlier in March, strongly led by the technology sector. However, GDP across countries was still contracting, and the worldwide unemployment rate was still at an all-time high.
Debt to Equity Ratio
Used to evaluate a company's financial leverage and is calculated by dividing a company's total liabilities by its shareholder equity.
Profit is the financial benefit realized when revenue from a business is higher than the costs and taxes involved in operating that business.
Alternative investment class composed of funds that invest directly in private companies or that buy public companies and take them private
Time of declining economic activity, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and sales.
A stimulus package is a coordinated effort by the government to increase spending and investment to "stimulate" an economy out of a downturn.
Shorting a stock
Trading strategy that tries to take advantage of the decline in a stock price by borrowing a stock and sell it now while planning to repurchase it later for a lower price.
Market-capitalization-weighted index tracking the performance of the 500 largest U.S. companies