How to trade and invest during inflation
You can hedge against inflation when you trade or invest in inflation-protected securities. Discover different ways you can beat the rising cost of goods and services as a result of inflation.
What is inflation?
Inflation is the measurement of the rising cost of goods and services in an economy. The rate at which the spending power of consumers decreases is reflective of the growing cost for companies to produce goods. This also includes the surge in expenses for raw materials and higher wages for the employees.
When the price level for goods and service decrease substantially, that effect is referred to as deflation. The central bank is responsible for adjusting the level of inflation using the monetary policy.
Typically, economists will announce the impending changes in inflation, presenting an opportunity for investors and traders to take a position on assets that do well during inflationary times.
How is inflation measured?
Inflation is measured using three common economic reports: the consumer price index (CPI), the producer price index (PPI), and the house price inflation. In the UK, there’s also the retail price index (RPI), which measures the consumer inflation that affects the retail prices of a basket of goods and services.
- The CPI measures the rate at which the average price for a basket of goods and services rises. It’s an economic instrument used by the Bank of England (BoE) policy makers when they consider measures to control inflation by increasing or decreasing interest rates
- PPI measures the increase or decrease in the selling prices received by domestic producers for their goods and service offerings
- The house price inflation measures changes in the price of residential housing as a percentage change from a specific time period
How does inflation impact different assets?
Inflation impacts assets differently depending on the type of financial instrument you want to get exposure to. The impact can affect your position positively or negatively depending on whether the rate increases or decreases in value.
For example, stocks have an inverse relationship with inflation – ie as inflation rises, stock prices tend to fall and as inflation falls, stock prices tend to rise. This dynamic is representative of the reaction to inflation in the short term, whereby there’s an overall economic slowdown or uptake that affects the stock market and consumer spending.
There are several asset classes that are resistant to the effects of inflation and can serve as a safe haven when it rises. Getting exposure to inflation-protected assets such as inflation-linked bonds, real estate investment trusts (REITs), value stocks and certain commodities like gold or oil can counteract the effects of inflation.
Getting exposure to certain commodities tends to give investors a viable safe haven during times of uncertainty. Precious metal like gold is often used as a hedging tool against inflation or currency devaluation.
According to a study conducted by the World Gold Council that stretches from 1971 to 2021, gold has returned 15% per annum on average when inflation has been higher than 3%, compared to just over 6% per annum when inflation has been sub-3%.1
When inflation goes up, you can buy gold, but you won’t necessarily take ownership of the physical commodity to get exposure. With us you’ll trade spot gold, futures or options on the gold price directly. Or you can trade or invest in gold ETFs or ETCs, or stocks in gold mining or producing companies.
Before you get exposure to gold, it’s important to remember that it’s priced in dollars, so there’s currency risk to consider. Additionally, because it’s such a popular hedging tool during times of uncertainty, getting exposure may be costly due to the high demand.
Investors have commonly diversified their portfolio during inflationary times to gain exposure to income-producing properties. When you get exposure to REITs, you benefit from the rising value of property and rental income in the long term, without taking ownership of the property outright.
REITs have commonly performed well in inflationary times because landlords tend to increase their rent when inflation goes up. If you take a position on REITs, you have to consider interest rates risk. For example, in a post-pandemic Europe, interest rates surged, and owning property hasn’t proved a fruitful investment due to lots of companies adopting a hybrid model or simply resorting to working remotely.
Therefore, before you get exposure, it’s important to consider the particular sector and the geographical region to which you want to be exposed. If either of these suffers, so will your REIT.
Investors with a long-term trading plan may buy into a company with a low valuation based on varying fundamental analysis metrics like price-to-earnings (PE) ratio. Value investing involves identifying stocks with the best growth potential in terms of share price, then taking a long position.
During times of uncertainty, some companies experience slow growth, or the stock price falls. This reaction can offer a great opportunity to traders and investors to hedge against inflation in the long run. This position is rooted in the belief that the company will adapt to the inflation over time and will adjust their own prices until revenue is restored, and normal profit rates are realised.
Index-linked gilts are government-issued bonds that are linked to inflation. The nominal coupon payment and final settlement payment are instruments that are adjusted based on the accrued inflation.
UK index-linked gilts are a popular asset to invest or trade as a response to rising inflation, because it has low risk of defaulting. This is because the bond’s coupons and final settlement amount may retain their real (ie inflation-adjusted) value over time, thereby protecting against inflation eroding your investment.
Another asset that tends to appreciate in value during inflationary times is oil. You can get exposure by buying the physical stock but not actual barrels of oil or speculating on oil company’s share price.
Like most commodities, the price is dictated by market forces of demand and supply. This makes the asset volatile and unpredictable. Looking at recent history, oil prices in emerging markets have been on the rise and could offer an opportunity to traders and investors to get exposure.
According to Wells Fargo, oil prices have jumped more than 40% during inflationary periods since 2000.2 If this pattern persists, it may be profitable to take a position in oil companies in the long run.
How to invest during inflation
- Create an account or log in
- Search for the stock, REIT or ETF you’d like to invest in
- Select ‘buy’ in the deal ticket (you can only go long when investing)
- Input the position size
- Open and monitor your position
Investing in financial instruments involves buying and taking ownership of the underlying asset. You’ll typically have a long-term trading strategy when you invest, in the hope that its value will appreciate over time.
During times of uncertainty, you can diversify your portfolio to include investments that are inflation-proof such as income-producing real estate, ETFs, value stocks, index-linked bonds and investment trusts.
With us, you’ll use our share dealing platform to invest in over 13,000 leading stocks, ETFs and funds. Taking ownership of any entity will give you voting rights and you’ll receive dividend payments if the company grants them.
How to trade during inflation
- Create an account or log in
- Choose between spread bets and CFDs and search for your opportunity
- Select ‘buy’ to go long, or ‘sell’ to go short
- Set your position size and take steps to manage your risk
- Open and monitor your position
Trading involves speculating on financial markets without taking outright ownership of those assets. When trading, you’ll be using derivatives like spread bets and CFDs to speculate on an asset’s price movements.
Note that derivative products can be traded on leverage, where both your profit and loss will be magnified. This is because your position is calculated based on the full size of the position, not the deposit. That’s why it’s important to take steps to manage your risk.
Using derivative products, you can hedge against inflation by going short on assets that fall in times of inflation using a short-term trading plan.
When inflation rises, there’s a negative effect on the stock market, with company shares and non-inflation-indexed bonds often falling in price. You can anticipate the market movement of certain shares and take a short position.
Alternatively, you can take a long-term approach by buying stocks that have dropped in hopes that the market can correct for the effects of inflation – meaning that the share prices and dividends will rise over time.
Latest news on inflation
Is inflation good for trading?
Trading during inflation offers different opportunities for you to speculate on the rising prices of goods and services in an economy by shorting the stocks.
Is it good to invest during inflation?
Inflation presents investors with the opportunity to get exposure to assets that have a lower price to buy and own outright, with the hope that they’ll appreciate in value over time.
What accounts can I use to start thematic investing?
You can open a share dealing account with us to start thematic investing. You can also transfer your shares from your current provider, with no charges for electronic shares. With no sign-up or exit fees, we can offer you the perfect home for your portfolio.
How do I hedge against inflation?
When you hedge against inflation, you’d either take an opposite position in a closely related market by shorting the stock if you thought that the share price would fall or take a position in the same market that moves inversely to your original investment.