Defensive Stocks Explained: Trading Non-Cyclical Stocks

Given the volatile and unpredictable nature of financial markets, many traders and investors look for ways to protect their portfolios and minimize potential losses. One strategy for achieving this is through defensive stock trading. 

In this article, we’ll explain what defensive stocks are, how to trade them effectively, and why they can play a crucial role in building a more resilient trading portfolio.

TL;DR

• Defensive stocks are shares of companies with stable earnings and dividends, even during economic downturns. 

• Examples of defensive stocks include Pfizer, McDonald's, and Coca-Cola. 

• Defensive stocks reduce risk during volatile markets, provide steadier income, and are easier for beginners to navigate. 

• Defensive stocks come from various industries like utilities, healthcare, and consumer staples.

What Are Defensive Stocks?

Defensive stocks, otherwise called non-cyclical stocks, are shares of companies that are known to have provided stable earnings and consistent dividends, even in times of economic uncertainty, tariffs and geopolitical tensions, and recessions. 

Why Trade Defensive Stocks?

Trading defensive stocks is often done in order to protect one’s trading portfolio from volatile and uncertain markets as these trading vehicles are relatively more stable. 

However, it is important to note that while defensive stocks can perform better than other types of stocks in recessionary economies, they perform below the market during periods of economic expansion due to their low beta (a measure of a security’s volatility/risk in relation to the overall market). 

Moreover, investors and traders may be drawn to defensive stocks due to the following reasons:

• Volatility-Reduction

During periods of economic volatility, pressure, or recession, market participants often turn to defensive stocks as a strategy to reduce the risk of losses.

• Easier to Navigate

Given their relative stability, defensive stocks may be less tricky to navigate and may suit some beginner traders.

• Steadier Revenue Stream

Compared to other types of stocks and financial assets, defensive stocks often provide a steady stream of income to traders and investors. (Source: Corporate Finance Institute)

Which Stock Types Are Considered Defensive?

Defensive stocks are multifaceted and stem from different industries, with the main ones being utilities, healthcare, and consumer staples. 

Utilities 

Basic life necessities such as water and energy sources (electricity and gas) are naturally in consistent demand and are more often than not considered stable. As such, companies from the utilities sector are considered defensive stocks.

Consumer Staples

Goods and services that include beverages, good, hygiene products, household items, among others, are also relatively in consistent demand, thereby companies involved in their production are considered defensive stocks. 

Healthcare

Pharmaceutical and healthcare products are also necessary for our daily lives, which means that companies involved in their making may be considered defensive stocks. (Source: Groww)

Popular Defensive Stocks: Defensive Stocks Examples

Popular defensive stocks encompass:

• Pfizer (PFE)

• The Campbell’s Co (CPB)

• General Mills (GIS) 

• Kimberly-Clark (KMB)

• Lockheed Martin Corp (LMT)

• Zimmer Biomet (ZBH)

• The Allstate Cop. (ALL)

• Consolidated Edison Inc. (ED) (Source: Money US News)

How to Trade Defensive Stocks 

Defensive stock trading can traditionally be done by directly buying and selling the underlying stocks. However, trading equity index Futures contracts may be a viable solution for traders seeking more flexibility, those wanting to gain exposure to both rising and falling defensive stock prices without actually owning the underlying shares, and accessing multiple defensive stocks at once.

Conclusion 

In conclusion, defensive stocks can offer a valuable strategy for traders looking to minimise risks during economic uncertainty. Their stable earnings and consistent dividends make them attractive in volatile markets. While they may underperform during economic growth, their resilience during downturns can provide a steady income stream and protect portfolios. Whether trading directly or through equity index Futures for added flexibility and leverage, defensive stocks remain key in balancing risk in any portfolio.

*Past performance does not reflect future results.