When equity markets enter a phase of increased risk, it is time to invest in defensive stocks to reduce the dangers, fundamental necessity for those who work on the long term: investing in defensive stocks means not giving up on the long term, minimizing the possible pitfalls.
There are more than one risk factors that should push us to adopt prudent behavior: just think of 2020, a year marked by the Covid crisis and the US presidential elections, always a great unknown but this time even more. Two drivers capable of greatly influencing the trading trend.
Investing in defensive stocks is essential when there is uncertainty (a lot of uncertainty). It is true that when you decide to invest in the stock market there is always a certain level of risk but by adopting the right choices the impact of this uncertainty can be limited.
What are defensive stocks
Defensive stocks are equities that have very low volatility. It is precisely the low volatility that makes these stocks safer in the long term. Tight oscillation margins mean lower earning potential, but this is the right price to pay to rest assured in a very turbulent market phase.
Defensive stocks are those of listed companies that offer products and services that are needed in all economic conditions, from recession to stagnation and through cycles characterized by strong GDP growth.
Utilities are an example of defensive stocks as they offer water, gas and electricity supply services that cannot be done without. And the same goes for many consumer goods, from tobacco to food, and passing through drinks and personal hygiene products.
In addition, even if they are not strongly countercyclical, listed companies in the pharmaceutical and medical device sectors are usually included among the defensive stocks as people always need treatment regardless of a recession or an economic boom.
Examples of defensive actions: NextEra Energy, Johnson & Johnson, The Kroger, Costco Wholesale, Brookfield Infrastructure Partners, Microsoft.
Why invest in defensive stocks
Despite the low volatility, you can invest in defensive stocks by trading on Contracts for Difference, indeed, perhaps it’s easier than with more volatile stocks. Stocks in the defensive sector are not immobile stones: I understand that for adrenaline-loving traders, the defensive sector may seem like a nuisance, but defensive stocks also have their price changes.
What is the advantage of investing in defensive stocks? Above all, being able to contain losses in the event of a violent sell-off of the markets and to restart earlier (and gradually) compared to other sectors. As some experienced traders repeat, when there is a stock market crash, defensive stocks fall but do not collapse (and this is essential).